Stock Return Volatility and Capital Structure Decisions∗

We comprehensively examine the effects of stock return volatility on firms’ financial and investment decisions. Consistent with theories of investment with financing frictions, firms with high volatility actively reduce their leverage, cut investment, increase cash holding, cut non-cash current assets such as inventories and account receivables, and cut dividend. The effects of volatility are stronger for firms with higher leverage and for firms with low cash holdings. Further decomposition of the volatility measure reveal that firms respond respond differently to expected volatility and volatility surprises, as well as to systematic and idiosyncratic volatility shocks. Finally, stock return volatility also significantly predicts future leverage adjustment and future investment. JEL Classification: G32, G17.