Financial flexibility and stock price reactions to the Covid-19 shock: Evidence from UK market

Abstract

The present study examines the relationship between financial flexibility and stock returns reactions to the Covid-19 shock in the UK market. Using a sample of 946 non-financial UK firms for February 20 to March 31, 2020, and employing three measures for financial flexibility (cash, leverage and payouts), the study finds that firms stock prices were negatively affected by the growth in the Covid-19 confirmed cases. However, the study shows that this negative effect on stock prices was less for firms that have pre-2020 high cash holdings and low leverage ratios while it was greater for firms that have low cash reserves and high debt. These results indicate that the pre-pandemic level of financial flexibility, measured by cash and leverage, has a role in affecting the relationship between Covid-19 and stock performance. For payout ratio, the research finds no evidence to indicate that the level of financial flexibility that measured by payout ratio has a moderating effect on the relationship between Covid-19 and stock returns. Moreover, the research also provides statistical evidence suggesting that the performance of firms with high financial flexibility is superior to that of firms with less financial flexibility by 12% during the pandemic. These findings support the results of much recent and prior literature on the relationship between financial flexibility and firm performance during crises.