Does real flexibility help firms navigate the COVID-19 pandemic? |
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Institution: | 1. University of Bristol Business School, University of Bristol, Howard House, Queen''s Avenue, Bristol, BS8 1SD, UK;2. Department of Accounting & Finance, Texas A&M University Central Texas, 1001 Leadership Pl, Founders Hall, Killeen, TX, 76549, USA;3. Queen''s Management School, Queen''s University Belfast, Riddel Hall, 185 Stranmillis Road, Belfast, BT9 5EE, UK |
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Abstract: | Building on the investment-based asset pricing framework, we show that firms' ability to timely scale down their operations reduces the sensitivity of their equity value to large adverse productivity shocks. Using U.S. data in the times of the COVID-19 pandemic, we provide empirical evidence consistent with our model's predictions. Real flexibility curbs losses in firm value and reduces return volatility, especially for firms with high book-to-market or high COVID-19 exposure, consistent with the idea that the benefits of real flexibility are associated primarily with contraction options during the COVID-19 crisis. Our analysis shows that real flexibility provides incremental and complementary protection beyond financial flexibility. Besides its impact on stock prices, real flexibility also helps firms sustain earnings during 2020, compared with 2019 when the pandemic had not struck. Our work demonstrates that real flexibility is an important tool for corporate managers in navigating episodes of disasters. |
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Keywords: | Real options Flexibility COVID-19 Price sensitivity Resilience G12 G31 |
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