Leverage and Cash Dynamics
Charles A. Dice Working Paper No. 2021-10
55 Pages Posted: 22 Jun 2021
Date Written: June 17, 2021
This paper documents new and empirically important interactions between cash-balance and leverage dynamics. Cash ratios typically vary widely over extended horizons, with dynamics remarkably similar to (and complementary with) those of capital structure. Leverage and cash dynamics interact approximately as predicted by the internal-versus-external funding regimes in Myers and Majluf (1984). Leverage is quite volatile when cash ratios are stable and vice-versa, while net-debt ratios are almost always volatile. Most firms increase leverage sharply as cash balances (internal funds) become scarce. Capital structure models that extend Hennessy and Whited (2005) to include cash-balance dynamics explain some, but not all, aspects of the observed relation between cash squeezes and leverage increases.
Keywords: capital structure, cash balances, leverage dynamics, financial flexibility, payout policy
JEL Classification: G31, G33, G35
Suggested Citation: Suggested Citation