Financial Flexibility and Short-Term Financing Needs: Evidence from Seasonal Firms

Abstract

Firms that face seasonal demand account for an important fraction of the U.S. economy. However, there is surprisingly little evidence on these firms' financing decisions. Yet, studying these decisions provides a natural setting to shed light on the types of capital (i.e. cash or debt) that firms use to manage short-term financing needs. Using seasonal firms as a setting to examine this issue, I show that seasonal financing needs are met with debt with low exposure to information asymmetry, such as short-term debt and trade credit. I further show that cash reserves, which have high carrying costs and can at time lead to agency problems, are not used for seasonal financing needs. Further, as financial flexibility theory would predict, I document that seasonal firms maintain more conservative financial policies to increase the ability to use debt for short-term financing needs. Specifically, seasonal firms are less levered and have long-term debt with a longer average maturity. Further, seasonal firms adjust toward leverage targets slower during fiscal quarters when debt is used for short-term financing. Overall, my findings indicate that firms minimize costs associated with short-term financing needs by using debt with low issuance costs and the use of this debt impacts the overall capital structure of the firm.