Discuss the financing hierarchy view of corporate liquidity - Essay Example

The Financing Hierarchy View of Corporate Liquidity: Theory and Practice The Financing Hierarchy View of Corporate Liquidity: Theory and PracticeThe idea of financing hierarchy, as presented by Opler, Pinkowitz, Stulz and Williamson (1999), argues that corporate liquidity cannot be expected to be at a perfect level because there is no perfect or optimum level of debt. As can be construed from the theoretical perspective of the pecking order, the level of cash maintained by a corporate entity is regarded as the natural consequence of the decisions made by that entity in relation to making investments and raising finance.

Hierarchy view is also suggestive of the same relationship between liquidity and corporate decisions. Considering this relationship predicted by the hierarchy view, it is different from the trade-off view which argues that the relationship between the level of cash and investment maintained by an entity is direct. The hierarchy view also holds that firms raise their levels of cash reserves when they are confident about their future profitability and the fact that new opportunities will require excessive cash reserves (Tirole 2006).

The empirical evidence in relation to the corporate policies on liquidity, based on the survey conducted by Deutsche Bank (2006), suggests that a significantly high level of companies surveyed, i.e. 18 percent, maintained liquid cash reserves which were more than 20 percent of their assets, whereas 38 percent survey participants had established credit lines over and above 20 percent of their assets’ value. On the other hand, one interesting finding from the survey revealed that about 50 percent of the participants signified their indifference towards changing liquidity position, had there been no new opportunities in the market (Servaes and Tufano 2006).

Thus, holding of cash cannot be deemed for availing new investment opportunities and this is where empirical evidence departs from hierarchy view of corporate liquidity policy.ReferencesOpler, T., Pinkowitz, L., Stulz, R. and Williamson, R., 1999. The Determinants and Implications of Corporate Cash Holdings. Journal of Financial Economics, 52, pp.3-46.Servaes, H. and Tufano, P., 2006. The Theory and Practice of Corporate Liquidity Policy. Deutsche Bank.Tirole, J., 2006. The Theory of Corporate Finance.

Princeton: Princeton University Press.