Premium
Financial Inflexibility and the Value Premium
Author(s) -
Poulsen Michael,
Faff Robert,
Gray Stephen
Publication year - 2013
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/irfi.12010
Subject(s) - value premium , leverage (statistics) , proxy (statistics) , economics , dividend , explanatory power , econometrics , context (archaeology) , financial economics , monetary economics , finance , capital asset pricing model , paleontology , philosophy , epistemology , machine learning , computer science , biology
Abstract This paper tests whether and to what extent the value premium is induced by financial inflexibility. In this context, financial flexibility refers to the ability of a firm to alter investment expenditure to mitigate exogenous shocks, so as to generate a smooth dividend stream. Consistent with a literature that identifies three related sources of inflexibility, we create a composite inflexibility index, based on the proportion of fixed assets and measures of total leverage and financial constraints. A positive relation is documented between inflexibility and the book‐to‐market ratio, and between the returns of inflexible firms and value firms. However, the value premium retains explanatory power independent of inflexibility, suggesting that it is not a proxy for inflexibility alone.