Financial Flexibility and Corporate Cash Policy

Using variations in local real estate prices as exogenous shocks to corporate financing capacity, we investigate the causal effects of financial flexibility on cash policies of US firms. Building on this natural experiment, we find strong evidence that increases in real estate values lead to smaller corporate cash reserves, declines in the marginal value of cash holdings, and lower cash flow sensitivities of cash. The representative US firm holds $0.037 less of cash for each $1 of collateral, quantifying the sensitivity of cash holdings to collateral value. We further find that the decrease in cash holdings is more pronounced in firms with greater investment opportunities, financial constraints, better corporate governance, and lower local real estate price volatility.

Keywords: Cash policy, Debt capacity, Collateral, Real estate value, Cash holding, Marginal value of cash, Cash flow sensitivity of cash

JEL Classification: G32, G31, G34, R30

Suggested Citation: Suggested Citation

Chen, Tao and Harford, Jarrad and Lin, Chen, Financial Flexibility and Corporate Cash Policy (October 2013). Finance Down Under 2014 Building on the Best from the Cellars of Finance, Available at SSRN: https://ssrn.com/abstract=2298628 or http://dx.doi.org/10.2139/ssrn.2298628