Sources of Financial Flexibility: Evidence from Cash Flow Shortfalls *

Naveen D. Daniel · David J. Denis · Lalitha Naveen

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Corporate Finance and Governance Financial Analysis and Corporate Governance Working Capital and Financial Performance

Abstract

Faced with cash flows that fall short of the sum of expected dividend and investment levels, firms must do one of the following: cut dividends, cut investment, or raise funds through security sales, asset sales or reductions in cash reserves. Our analysis indicates that while very few firms (6%) cut dividends, the majority (68%) make significant cuts in investment relative to expected levels. Investment cuts make up for approximately half of the shortfall, with the other half being covered primarily by debt financing. Net equity issues, reductions in cash balances and asset sales account for a trivial percentage of the shortfall. Our findings challenge several widely-held views in the corporate finance literature. JEL classification code: G35

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References

1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1968FINANCIAL RATIOS, DISCRIMINANT ANALYSIS AND THE PREDICTION OF CORPORATE BANKRUPTCY 1984The Capital Structure Puzzle 1961Dividend Policy, Growth, and the Valuation of Shares 2005The economic implications of corporate financial reporting 1987Financing Constraints and Corporate Investment 1999The determinants and implications of corporate cash holdings 2004The Cash Flow Sensitivity of Cash

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