Abstract
This paper addresses the buffering function of financial slack (understood as the pool of available resources) in the company from risk management perspective. The main purpose of this paper is to study the relationship between financial slack and risk retention, as one of risk management strategies. Risk retention is here considered as a risk financing method, whereby a company intentionally assumes the self-sufficient coverage of the negative financial outcomes of risk. The paper offers an original, conceptual model of the assessment of the company’s risk retention capacity, as determined by the existence of financial slack. It considers more-in-depth three main strategies of risk retention: earmarked capital reserves, compensation and contingent financing and links them with the three types of financial slack: available, recoverable and potential one, respectively. The contribution of the study is manifold. Firstly, it defines and systemizes the category of a financial slack in the broad meaning, together with its measures. Secondly, it offers an original, conceptual model of the application of the financial slack measures to the assessment of the company’s risk retention capacity. Finally, it provides the empirical illustration of the sector-relativity of the existence of risk retention capacity, based on the financial data of the 500 largest Polish companies. This empirical illustration is executed separately for each of the distinguished risk retention strategies and linked to the presence of a various types of financial slack.
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Notes
- 1.
Bourgeois proposal was to capture the relationship of short-term loan interest (I) compared to principal rate (P). Bourgeois (1981: 38).
- 2.
- 3.
With reference to the seminal work of Miller and Modigliani, the empirical works have led to the justification of static trade-off theory of leverage, agency trade-off theory, signaling theory, pecking-order theory and market-timing theory. An overview of the premises of these theories was provided by e.g. Ehrhardt and Brigham (2009), Eldomiaty (2008), Myers (2001), Ross (1977), Baker and Wurgler (2002).
- 4.
Alternatively, risk compensation capabilities could be analysed from the cash flow perspective: as a relationship between cash outflows to cash inflows.
- 5.
Recently, Poland has also been promoted to developed market status run by FTSE Russel and Stoxx, although it remains in the emerging-market category for MSCI (Martin 2018).
- 6.
The PDK (Polish Industrial Classification) system is consistent with NACE rev. 2 (Statistical Classification of Economic Activities in the European Community) and uses digit coding with very detailed explanation of the areas of company’s operating activity. Thus companies could be easily classified into larger sectors (in this case production, trade, energy and construction). The sector related sub-samples examined in this study are regarded as the key sectors in the Polish economy. According to national statistics data for 2017, companies operating in the four sectors included in our study, represent c.a. 70% of the Polish economy (GUS 2017).
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Wieczorek-Kosmala, M., Błach, J. (2019). Financial Slack and Company’s Risk Retention Capacity. In: Linsley, P., Shrives, P., Wieczorek-Kosmala, M. (eds) Multiple Perspectives in Risk and Risk Management. Springer Proceedings in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-030-16045-6_6
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