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Does real flexibility help firms navigate the Covid-19 pandemic?

Journal: The British Accounting Review

Date: 2023

Author: Tuan Ho, Kirak Kim, Yang Li, Fangming Xu

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.

Link: Google Scholar

Background and Context

Research Context

The COVID-19 pandemic triggered unprecedented stock market crashes and the worst economic crisis since the Great Depression, creating an urgent need to understand how firms can build resilience.

Research Focus

This study examines how firms' ability to scale down operations (real flexibility) affected their performance during the COVID-19 crisis compared to financial flexibility.

Methodology

Analysis of U.S. non-financial firms during February-March 2020 market crash using stock returns data and measures of real/financial flexibility.

Real Flexibility Provides Protection During Market Crash

Firms with high real flexibility experienced less negative returns during the market crash period
High flexibility firms saw returns about 12% better than low flexibility firms
Demonstrates real flexibility's protective effect during economic crisis

Stronger Benefits for Firms Most Affected by COVID-19

Real flexibility benefits were 5x larger for firms with high COVID-19 exposure
Shows real flexibility was most valuable when most needed
Validates importance of operational adaptability during crisis

Real Flexibility Reduces Return Volatility

Higher real flexibility led to lower stock return volatility
Effect remains significant after adjusting for market risk
Demonstrates stabilizing effect of operational adaptability

Real Flexibility Complements Financial Flexibility

Real flexibility benefits were larger for firms with low financial flexibility
Shows real flexibility provides complementary protection
Highlights importance of operational adaptability when financial resources are constrained

Sustained Earnings Performance During Crisis

Real flexibility's positive effect on earnings nearly doubled during crisis year
Shows operational adaptability helped maintain profitability
Demonstrates real benefits beyond stock market performance

Contribution and Implications

Real flexibility provides crucial protection during economic crises, comparable in magnitude to financial flexibility
Operational adaptability is especially valuable for firms with limited financial resources or high crisis exposure
Managers should consider developing real flexibility as a strategic tool for crisis resilience

Data Sources

Return comparisons based on Table 3 showing regression results of real flexibility on collapse period returns
COVID-19 exposure analysis derived from Table 8 comparing high/low exposure subsamples
Volatility effects taken from Table 13 showing impact on return standard deviation
Financial flexibility interaction based on Table 5 comparing effects across different levels of financial flexibility
Earnings performance sourced from Table 15 comparing 2019 vs 2020 ROA regressions