Financial flexibility and the performance during the recent financial crisis

Abstract

Purpose The objective of this study is to test whether financial flexibility has value. Using the current financial crisis, the authors investigate whether firms that built up financial flexibility over the years preceding the crisis yield superior performance during the financial crisis. Design/methodology/approach Financial flexibility is measured along the following dimensions: cash and cash equivalents, debt (short-term and total) and net debt. These proxies are measured as an average over the five years prior to the crisis, from September 2002 to August 2007. Firms are then sorted into ten portfolios and monthly stock returns for each portfolio are evaluated over the crisis period from September 2007 to March 2010. Findings The authors' results show that high pre-crisis levels of cash do not seem to have a positive impact on firm value during the crisis. However, the results provide evidence that high pre-crisis levels of debt had a negative impact on firm value during the latest financial crisis, supporting the hypothesis that financial flexibility has value. Originality/value The originality of the authors' approach is to evaluate the value of financial flexibility during a financial crisis. The recent financial crisis offers an ideal test case to evaluate whether financial flexibility has indeed value for the firm.

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