Residual Cash, Firm Value and Financial Distress

Document Type

Article

Department or Administrative Unit

Finance and Supply Chain Management

Publication Date

10-2012

Abstract

This paper examines how a company's market value can be affected by residual cash, and whether corporate liquidity and negative residual cash can predict bankruptcy. The empirical evidence shows that deviation from the target or optimal cash is value destructive, which provides support for the tradeoff theory. However, the impact of residual cash on market value of equity is not symmetric: positive residual cash tends to reduce firm value less than negative residual cash. In general, firms with negative residual cash are more likely to experience financial distress since they are smaller, less profitable, generate lower cash flows, and have higher leverage but weaker payoff ability. Furthermore, logistic regression results suggest that negative residual cash serves as an important predictor variable for bankruptcy. The probability of filing bankruptcy is higher for firms with negative residual cash. Finally, negative residual cash contributes to different default probabilities (Altman's Z-score, Vassalou and Xing's default likelihood indicator and Chava and Jarrow's default probability) estimated in previous literature.

Comments

This article was originally published in Journal of International Finance and Economics.

Journal

Journal of International Finance and Economics

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