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Financial Constraints, Real Options and Corporate Cash Holdings

44 Pages Posted: 31 Jan 2013  

Cyrus A. Ramezani

California Polytechnic State University, San Luis Obispo

Date Written: August 1, 2012

Abstract

We posit that firms with valuable real options have higher demand for cash and liquid assets and propose a simple procedure for identifying firms with valuable real options. Our procedure assumes that, all else being equal, a firm's real options are more valuable when their underlying volatility is high and when the firm is not financially constrained. The financial flexibility resulting from large cash holdings enable firms to optimally exercise valuable real options without reliance on capital markets, which may reveal the firm’s strategic decisions to its competitors. We consider several measures of underlying risk and financial flexibility. Using data from a large sample of US companies, we categorize firms as having high volatility and high financial flexibility. We then study the determinants of demand for liquidity for each group of firms. We find that firms with valuable real options (high volatility and high financial flexibility) have significantly higher cash holdings. Our finding offers new insights about the interaction between financing constraints, a firm's portfolio of real options, and its demand for liquidity.

Keywords: corporate cash holdings, real options, financial constraints

JEL Classification: G31, G32, G35, G38

Suggested Citation

Ramezani, Cyrus A., Financial Constraints, Real Options and Corporate Cash Holdings (August 1, 2012). Available at SSRN: https://ssrn.com/abstract=2208942 or http://dx.doi.org/10.2139/ssrn.2208942

Cyrus A. Ramezani (Contact Author)

California Polytechnic State University, San Luis Obispo ( email )

School of Business
San Luis Obispo, CA 93407
United States

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