Financial Flexibility and Firm Behavior: Evidence from Emerging Market

Abstract

investment opportunities that increase shareholder value. Therefore, the purpose of this study is twofold: to explore the difference in characteristics of financially flexible firms from non–flexible firms. Secondly, to investigate the effects of this flexibility on financial decisions and the value of a firm. The sample is drawn from the KSE100-indexed firms listed at the Pakistan Stock Exchange, showing 80 percent of the market capitalization. The data is collected for eight years from 2015-2022. The ordinary least square regression with year and industry fixed effect is used to estimate the proposed hypotheses. The results of the study revealed that financial flexibility has a significant and positive effect on the profitability, dividend payout, and cash holdings of Pakistani firms. At the same time, it significantly negatively influences the firm's value and investment ability. The results reveal a significant difference between financially flexible firms. FF firms have higher ROA, cash holdings, and dividend payout than non-FF firms and lower leverage ratios than non-FF firms. Financial decision-making has a significant effect on the firm value. The consequences of maintaining financial flexibility or low leverage below the optimal debt level remain a puzzle. The financial markets need to improve, which provides more debt and equity securities for firms to improve their financial mix. The stock market improvement also adds to the emerging market's economic health. This study added to the limited literature on financial flexibility or low-leverage puzzle in the emerging market. The results prove that listed firms maintain their debt capacity to avoid future uncertainty when profitable investments are available.