The interaction between leverage and cash-balance dynamics : An empirical study of time-series variation in leverage and cash-balance ratios in publicly listed firms in the Nordics

Abstract

This paper investigates whether time-series variation in leverage can be linked to hypothetical cash-balance squeezes for Nordic firms. The methodology in this paper is based on the article by DeAngelo, H., Concalves, A. S., & Stulz, A. S. (2022). We uncover that high time-series variation in leverage and cash-balance ratios is the norm for firms facing hypothetical cash squeezes in the period January 2000 to December 2021. Capital expenditures are found to be the main users of funds and the primary driver of time-series variation in leverage ratios. Overall, we document an empirical link between leverage and cash-balance dynamics. Over extended time periods, cash ratios display wide variations that closely resemble and complement the dynamics of capital structure. The interactions between leverage and cash dynamics align with the predictions of the internal-versus-external funding regime outlined in Myers & Majluf (1984). When cash ratios remain stable, leverage tends to be highly volatile, and vice versa. Net-debt ratios are almost always volatile. As internal funds (cash balances) become scarce, most firms significantly increase their leverage. The latter is especially true for firms delisted due to bankruptcy or liquidation. In sum, we report that there exists an interaction between leverage and cash balances. Consequently, researchers and companies should start to consider the two financial items as co-dependent rather than univariate variables. The research in this paper is placed in the intersection between the research fields of capital structures and cash balances, providing valuable insights to the small research field of leverage and cash dynamics.