Corporate sensitivity to sovereign credit distress: the mitigating effects of financial flexibility

This paper investigates the role of financial flexibility in sovereign-corporate rating nexus. Using a panel data of non-financial European firms rated by S&P during 2005-2022, we show that financially flexible firms are more protected from the consequences of sovereign rating downgrades than their financially inflexible counterparts. Financial flexibility becomes particularly valuable for corporates in GIIPS countries, during the European sovereign debt crisis and the COVID-19 pandemic. Finally, private firms benefit more from financial flexibility than public firms due to their financing constraints. Our findings have implications for corporate managers, governments, and regulators alike, as financial flexibility can act as a shield against sovereign risks’ shocks.