Flexibility costs of debt: Danish exporters during the cartoon crisis

We study how firms respond to an unexpected demand shock, exploiting the 2006 boycott of Danish products after publication of Muhammad caricatures. On average, affected firms lose the majority of their exports to Muslim countries and experience a significant decrease in total sales. However, firms with low financial leverage redirect sales to new and existing product-destination markets in non-Muslim countries, which allows them to fully offset their losses. In contrast, high-leverage firms do not enter new markets and instead actively downsize. Our results highlight the importance of financial flexibility in times of crisis, consistent with declarations of practitioners.