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

52 Pages Posted: 26 May 2005

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 4 versions of this paper

Date Written: February 2005

Abstract

We model the interplay between cash and debt policies in the presence of financial constraints. While saving cash allows constrained firms to hedge against future cash flow shortfalls, reducing current debt - 'saving borrowing capacity' - is a more effective way of securing investment in high cash flow states. This trade-off implies that constrained firms will allocate 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). Those same firms, however, will use free cash flows to reduce current debt if their hedging needs are low. The empirical examination of debt and cash policies of a large sample of 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 leaving their debt positions unchanged. In contrast, constrained firms with low hedging needs direct most of their 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.

Keywords: Cash holdings, debt policies, hedging, financing constraints, risk management

JEL Classification: G31

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Almeida, Heitor and Campello, Murillo, Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies (February 2005). Available at SSRN: https://ssrn.com/abstract=729883

Viral V. Acharya (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

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HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Heitor Almeida

University of Illinois at Urbana-Champaign ( email )

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HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

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Murillo Campello

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

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Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

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