Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies

Viral Acharya, Heitor Almeida and Murillo Campello

No 11391, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We model the interplay between cash and debt policies in the presence of financial constraints. While saving cash allows financially constrained firms to hedge against future income shortfalls, reducing debt - "saving borrowing capacity" - is a more effective way of securing future investment in high cash flow states. This trade-off implies that constrained firms will allocate excess cash flows into cash holdings if their hedging needs are high (i.e., if the correlation between operating cash flows and investment opportunities is low). However, constrained firms will use excess cash flows to reduce current debt if their hedging needs are low. The empirical examination of cash and debt policies of a large sample of constrained and unconstrained firms reveals evidence that is consistent with our theory. In particular, our evidence shows that financially constrained firms with high hedging needs have a strong propensity to save cash out of cash flows, while showing no propensity to reduce outstanding debt. In contrast, constrained firms with low hedging needs systematically channel free cash flows towards debt reduction, as opposed to cash savings. Our analysis points to an important hedging motive behind standard financial policies such as cash and debt management. It suggests that cash should not be viewed as negative debt.

JEL-codes: G31 (search for similar items in EconPapers)
Date: 2005-06
New Economics Papers: this item is included in nep-acc, nep-bec and nep-fin
Note: CF
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Citations: View citations in EconPapers (35)

Published as Acharya, Viral V. & Almeida, Heitor & Campello, Murillo, 2007. "Is cash negative debt? A hedging perspective on corporate financial policies," Journal of Financial Intermediation, Elsevier, vol. 16(4), pages 515-554, October.

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Journal Article: Is cash negative debt? A hedging perspective on corporate financial policies (2007)
Working Paper: Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies (2005)
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