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Financial Conservatism. Determinants of cash and leverage conservatism in USA firms.
Finance & Accounting
Pages 20 (5020 words)
The financial crisis, conservatism and distress; evidence from industrial US firms I. Introduction The global financial crisis has made firms face many difficult challenges. Retaining financial flexibility, which is the ability to respond adequately to unexpected events, has become very important for firms in the backdrop of the current financial crisis.
Microsoft, Exxon, Apple are all examples of non-financial firms that have held huge stockpiles of cash1. According to a recent San Francisco Chronicle report, Apple reportedly has a stockpile of $137 Billion, and the company justifies this by saying that it is “preserving its options”2. In financial literature, a firm which holds more cash reserves or lower leverage than is optimal according to capital structure is known to be financially conservative. To avoid having to depend on costly external sources of debt, having spare debt capacities by maintaining low liabilities to total asset ratios is important. Also for the same reason, retaining adequate cash reserves is also important. From 1980 to 2004, the average cash-to-asset ratio for industrial US firms has increased by 129 percent. During the same time period, net debt for these firms has fallen substantially (Bates et al, 2009). Therefore, on average these firms seem to have adopted more financially conservative practices in both senses by reducing leverage and increasing cash holdings simultaneously. However, much of the reduction in net debt is attributed to higher cash holdings rather than any reduction in liabilities. In general financial conservatism has become a very relevant topic of study in this backdrop. ...
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