Is Operating Flexibility Harmful Under Debt?

Operating flexibility is normally an asset, but under debt it can invite risk-shifting — and we find the resulting borrowing costs can erase more than a third of a firm’s value. We then ask whether the covenants lenders actually write can restore it. Simple financial covenants suffice when the firm can liquidate inventory mid-season; richer forms of flexibility demand more.

Management Science, vol. 63, no. 6, pp. 1730–1761