Assessment of the feasibility of establishing financial slack in a company: The model and its empirical verification

Abstract

Financial slack refers to excessive financial resources of a company that exist in addition to those that are necessary for operating activities. Is it feasible for a company to create financial slack? The answer to this question is ambiguous. On the one hand, the existence of slack provides a company with resources that can be used, for example, in case of financial constraints or for investing. On the other hand, the creation of financial slack means that the underlying cash reserves cannot be used for other purposes, for example, for distribution to stockholders. The paper presents the model for valuing a company’s financial slack that builds on the investment motive for forming the slack. The slack itself is considered to be a real option. The proposed model stipulates the conditions under which the creation and storage of financial slack is expedient. Those conditions are determined by the current value of business as well as by its riskiness. The empirical verification of the model was conducted by using the sample of 180 Russian public companies, the shares of which were traded in 2012–2019. The study confirmed that the return on financial slack in the current period will be higher specifically for those companies which were recommended to form financial slack in the prior period according to the proposed theoretical model.