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Financial flexibility and social distancing in the face of disaster : an empirical study on the US stock market during the COVID-19 pandemic

Nervold, Ragnhild Elise Garte; Øverli, Marius Jensen
Master thesis
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URI
https://hdl.handle.net/11250/2767934
Date
2021
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  • Master Thesis [4657]
Abstract
The objective of our study is to examine the mechanisms of the corporate balance sheet

during the exogenous COVID-19 crisis. The Fama-MacBeth methodology is employed on

the US stock market, controlling for industry and common market risk factors. We argue

that financially flexible firms, i.e. firms with more cash and less debt, should have less risk

and be better shaped than their inflexible counterparts to fund a revenue shortfall. We find

that financially flexible firms have 12.4% higher returns than inflexible firms when using

book leverage, and 20.5% when using market leverage. The higher returns correspond to

a 23.2% and 38.4% lower stock price reduction for the flexible firm, dependent on debt

metrics. We document that the return gap between financially flexible and inflexible firms

remains fairly constant throughout the market recovery, and hence that our results can

not be due to the increased elasticity of equity. We argue that market leverage is a better

overall measurement of debt capacity and firm risk. When addressing industry exposure

to COVID-19, we claim that the importance of financial flexibility should be magnified

(reduced) for firms with high (low) fundamental exposure. We do not find that resilient

firms benefit less from financial flexibility. Exposed firms gain from higher cash holdings

prior to the stock market crash. This effect seems to be reversed after the FEDs market

intervention on March 23rd, although the results are ambiguous. Market leverage suggests

no magnified effect from debt for exposed firms. However, again our metrics provide

conflicting results. Also here we argue that market leverage is more in line with economic

rationale.

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