Managerial cash use, default, and corporate financial policies

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2014-08, Vol.27, p.305-325
• Main Author: Arnold, Marc
• Format: Article
• Language: English
• Subjects: Bankruptcy; Cash management; Corporate finance; Default; Default risk; Excess cash; Managerial control; Risk assessment; Stockholders; Studies
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2014.05.014

This article investigates the impact of the observation that managers can use cash to defer bankruptcy on default risk and corporate financial policies. I show that with managerial cash use to defer default, the impact of cash on default risk depends on two opposing channels. While cash provides managers with a buffer against bankruptcy during difficult times, it also reduces equityholders’ willingness to contribute funds to the firm, which increases bankruptcy risk. The total impact of cash on default risk is driven by firm and industry characteristics that affect the relative importance of these two channels. As managers’ propensity for excess cash holdings depends on this total impact, the model explains observed excess cash levels, their determinants, and a wide range of empirical regularities of corporate cash holdings properties. •I examine the impact of managerial cash use to defer default on corporate policies.•I derive the relationship between cash and default risk.•Managers target excess cash because cash can be used to defer default.•Excess cash is positively related to firm risk and indirect distress costs.•Managerial cash use explains empirically documented cash regularities.