Do Nonfinancial Firms Use Financial Assets to Take Risk?

Abstract

Using hand-collected data on financial asset portfolios and exploiting the 2014 oil price crisis as an exogenous cash flow shock, we investigate financial risk-taking at distressed firms. We find that distressed firms, with high debt rollover risk proxied by short-term liabilities, substantially increase their investments in risky financial assets, including corporate debt, equity, and mortgage-backed securities. The effects are stronger for unhedged firms with low collateral assets. Overall, we provide new evidence that distressed firms take risk using financial assets camouflaged as cash reserves, which, compared to real assets, are less visible and carry lower transaction costs and accelerated payoffs.

Keywords: Cash Holdings, Short-term debt, Rollover Risk, Investment Securities, SFAS 157, Fair Value

JEL Classification: G30, G32, G33