Inflexibility and Leverage

Firms’ inflexibility to adjust their scale persistently explains capital structure variations in a comprehensive sample and randomly selected subsamples. Higher inflexibility leads to lower financial leverage, potentially due to higher default risk and lower value of tax shields. Contraction inflexibility determines leverage more than expansion inflexibility. Moreover, our inflexibility measure explains financial leverage significantly better than other variables that potentially capture certain aspects of adjustment costs for capital or labor. In addition, inflexible firms increase leverage more following a positive credit supply shock. Analyses employing instrumental variables estimation confirm our main finding. Our results suggest inflexibility shapes corporate financial policies. This paper was accepted by Bo Becker, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.08672 .