The dynamic relationship between firms’ cash reserves and financial leverage: evidence from MENA emerging markets

Purpose - This paper investigates the impact of financial leverage on corporate cash holdings in the Middle East and North African (MENA) emerging markets. Design/methodology/approach - The author applies the dynamic modeling approach to data from nonfinancial firms listed in 10 MENA countries between 2010 and 2019. The empirical model avoids the shortcomings of the prior literature by including indicators of the dynamics of the financial leverage to account for its persistence in the corporate cash holdings reserves. Findings - This research reports a significant negative relationship between corporate cash holdings and financial leverage. The results support the pecking order model, suggesting that leverage can be regarded as a substitute for holding a larger amount of cash and marketable securities. The author argues that the negative relationship between financial leverage and corporate cash holdings reinforces the precautionary motive to have internal cash reserves rather than external debt to support capital and investment activities by firms in the MENA emerging markets. Practical implications - The results of this research provide important insights into cash and capital structure management for nonfinancial listed firms in the MENA emerging markets. Specifically, the paper will help managers to understand the dynamic financial leverage determinants of holding cash in corporations in the MENA emerging markets and encourage policymakers to financially determine the corporate capital structure and cash holdings based on cost and benefits. Managing the firm's capital structure and cash holdings based on trade-offs between costs and benefits would enhance operating cash flow which may play an important role in creating value for shareholders. Originality/value - Prior studies have commonly been concerned with the determinants of corporate cash holdings, but few have investigated the dynamic financial leverage determinants of corporate cash holdings. This paper draws attention to this issue within the context of MENA emerging markets. To the authors' best knowledge, this is the first study that explores the relationship between cash holdings and financial leverage in MENA emerging markets.