Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies
Posted: 30 Apr 2007
We show theoretically that while cash allows financially constrained firms to hedge future investment against income shortfalls, reducing current debt is a more effective way to boost investment in future high cash flow states. Thus, constrained firms prefer higher cash to lower debt if their hedging needs are high, but lower debt to higher cash if their hedging needs are low. We provide empirical evidence that supports our theory. Our analysis points to an important hedging motive behind cash and debt management policies. It suggests that cash should not be viewed as negative debt in the presence of financing frictions.
Keywords: Risk management, financing frictions, investment, cash policy, debt capacity
JEL Classification: G31
Suggested Citation: Suggested Citation