Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies
University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)
Viral V. Acharya
New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance
Cornell University; National Bureau of Economic Research (NBER)
May 16, 2006
London Business School IFA Working Paper Series
We model the interplay between cash and debt policies in the presence of financial constraints. While saving cash allows financially constrained firms to hedge future investment against income shortfalls, reducing current debt (saving debt capacity) is a more effective way to boost investment in future high cash flow states. This tradeoff implies that constrained firms will prefer cash to debt capacity if their hedging needs are high (i.e., if the correlation between operating income and investment opportunities is low), but will prefer debt capacity to cash if their hedging needs are low. The empirical examination of cash and debt policies of a large sample of constrained and unconstrained firms reveals evidence that is consistent with our theory. In particular, financially constrained firms with high hedging needs show a strong propensity to save cash out of cash flows, while displaying no propensity to reduce debt. In contrast, constrained firms with low hedging needs systematically channel cash flows towards debt reduction, as opposed to cash savings. Our analysis points to an important hedging motive behind standard financial policies such as cash and debt management. It suggests that cash should not be viewed as negative debt in the presence of financing frictions.
Number of Pages in PDF File: 50
Keywords: Risk management, financing frictions, investment, cash savings, debt capacity
JEL Classification: G31, G32
Date posted: January 19, 2005
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