Subject：Inferring Financial Flexibility: Do Actions Speak Louder than Words?

Guest：Xuenan LI, Professor, CKGSB

Host：Zhongzhi SONG, Associate Professor, ACEM

Time：10:00-11:30am. Dec. 4, 2023 (Friday)

Venue：B207, Antai Building

Abstract:

Firms invest intermittently, and a significant part of capital formation occurs during “investment spikes”. Industry-level “spike waves”, during which growth opportunities in an entire industry surge and a large fraction of firms in the industry generate invest- ment spikes, also occur quite regularly. We define financial flexibility as the capacity to accommodate large shortfalls between a firm’s investment needs and cash flows, as is the case when it has an investment spike. We develop an index for financial flexibility (FF) based on which firm-specific variables differentiate firms that generate investment spikes and those that do not during industry spike waves. In out-of-sample tests, our FF Index outperforms five popular financial constrained (FC) indices in predicting in- vestment spikes, as well as regular investment and R&D investment. We use ChatGPT to evaluate the financial constraint status of a large sample of firms based on manage- ment statements in 10-Ks and generate new financial constraint measures; however, FF also outperforms these measures. The superior performance of our FF measure suggests that firms’ actions are more revealing of their financial status and its determinants than what is disclosed in annual reports. We validate our empirical approach using data sim- ulated in a model adapted from Gao, Whited, and Zhang (2021). As an application, we show that the FF Index predicts the capacity of firms to sustain investment during economic downturns, and again outperforms the FC Indices.

Guest Bio：

Erica X.N. Li is a Professor of Finance at Cheung Kong Graduate School of Business. Professor Li holds a Ph.D. in Finance with a minor in Macroeconomics from the University of Rochester and a Ph.D. in Physics from the University of Massachusetts, Amherst. She also holds bachelor’s degrees in Physics and Economics from Peking University. Professor Li has taught in a variety of topics in Finance at undergraduate, MBA, executive MBA level in US and China. Her research covers topics such as stock return anomalies, structural estimation of dynamic models, effects of financial friction on corporate policies, and the effects of monetary and fiscal policies on asset prices. She serves as the associate editor of the International Review of Finance and of the Quarterly Journal of Economics and Management.