Do Firms Prefer Leverage Over Cash?

Abstract

Amid record levels of corporate cash and debt, this study finds that firms acquire cash, then subsequently increase debt instead of reducing debt after the Homeland Investment Act of 2003. Two possible motives for this change are 1) increasing tax benefits of debt and 2) the role of cash as debt collateral. Using all firm panel observations from 2003-2019 (ex. financials and utilities), I find one dollar of cash has 3x more predictive ability for future debt than one dollar of financing deficit. Larger multinationals have increasing debt preferences over cash, a convex relation predicted by the repatriation tax motive. Surprisingly, domestic-only firms also prefer debt irrespective of hedging needs, and financially constrained firms (identified by sentiment analysis and Altman's Z) increasingly benefit from using cash as debt collateral. Persistently low corporate borrowing rates likely alleviated debt and hedging costs, inducing a new trade-off paradigm where firms may increasingly prefer to finance with debt instead of cash.