Investment-based asset pricing research highlights the role of irreversibility as a determinant of firms’ risk and expected return. In a neoclassical model of a firm with costly scale adjustment options, we show that the effect of scale flexibility (i. e., contraction and expansion options) is to determine the relation between risk and operating leverage: risk increases with operating leverage for inflexible firms, but decreases for flexible firms. Guided by theory, we construct easily reproducible proxies for inflexibility and operating leverage. Empirical tests provide support for the predicted interaction of these characteristics in stock returns and risk.

Abstract Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. Equity financed investment transfers wealth from equity to debt because asset volatility declines and earnings increase when firms invest. Financing asset sales reduce asset collateral and, hence, transfer wealth back from debt to equity. Exploring the dynamics of the heretofore overlooked “asset sale versus external equity” financing margin across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

Investment-based asset pricing research highlights the role of irreversibility as a determinant of firms' risk and expected return. In a neoclassical model of a firm with costly scale adjustment options, we show that the effect of scale flexibility (i.e., contraction and expansion options) is to determine the relation between risk and operating leverage: risk increases with operating leverage for inflexible firms, but decreases for flexible firms. Guided by theory, we construct easily reproducible proxies for inflexibility and operating leverage. Empirical tests provide support for the predicted interaction of these characteristics in stock returns and risk.

We study a novel aspect of a firm’s capital structure, namely, the profile of its debt maturity dates. In a simple theoretical framework we show that the dispersion of debt maturities constitutes an important dimension of capital structure choice, driven by firm characteristics and debt rollover risk. Guided by these predictions we establish two main empirical results. First, using an exogenous shock to rollover risk, we document a significant increase in maturity dispersion for firms that need to roll over maturing debt. Second, we find strong support that maturities of newly issued debt are influenced by pre-existing maturity profiles.