Price Risk, Production Flexibility, and Liquidity Management: Evidence from Electricity Generating Firms

55 Pages Posted: 24 May 2017

See all articles by Chen Lin

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2017

Abstract

Production inflexibility together with product price uncertainty creates price risk, which is a potentially important factor for firms’ liquidity management. One industry for which price risk can be measured is the electricity producing industry. We use data on hourly electricity prices in 41 markets to measure fluctuations in output prices and information on over 60,000 power plants to approximate firms’ flexibilty to vary output quantities. Our results suggest that higher electricity price volatility leads to increased cash holdings, but only in firms using inflexible production technologies. This effect is robust to a number of specification choices including instrumenting for volatility in electricity prices using weather forecast data. After deregulation, firms hold 20-25% more cash, suggesting that the process of deregulation increases the risk firms’ face. Price risk affects cash holdings most in financially constrained firms, and in firms that cannot easily hedge the electricity price through derivative markets. Capital market liquidity and balance sheet liquidity appear to be substitutes for one another.

Suggested Citation

Lin, Chen and Schmid, Thomas and Weisbach, Michael S., Price Risk, Production Flexibility, and Liquidity Management: Evidence from Electricity Generating Firms (May 2017). NBER Working Paper No. w23434. Available at SSRN: https://ssrn.com/abstract=2971812

Chen Lin (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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