Financial Flexibility and Investment Ability Across the Euro Area and the UK

Abstract We use a very large sample of European private and public firms to show that financial flexibility attained through a conservative leverage policy is more important for private, small‐medium‐sized, and young firms and for firms in countries with less access to credit and weaker investor protection. Further, using the 2007 financial crisis as a natural experiment, we show that a higher degree of financial flexibility allows firms to reduce the negative impact of liquidity shocks on investment. Our findings support the hypothesis that financial flexibility improves companies' ability to undertake future investment, despite market frictions hampering possible growth opportunities.