Liquidity is the most important factor of risk management, this is proven by the recent financial crisis of 2008 and 2011
The researchers Bolton, Chen and Wang propose in the document ’A Unified Theory Of Tobin’s Q’, a model of Investment and Corporate Financial Risk Management of a business that is in financial constraint. Bolton Chen and Wang explain that internal liquidity and credit line are the most important factors of any business that find themselves in financial constraint. The most important conclusion of this research are: (1) investments are highly dependant on Tobin’s q (2) optimum external financing are predominantly influenced by the capacity of capital balance and (3) liquidity management and hedging assets by means of diversion are complimentary risk management tools.
The researchers Bolton, Chan and Wang propose in this paper “A Unified Theory of Tobin’s Q” that corporate investment and financial risk management is a model that proofs how external financial costs make an impact on the overall internal investment and risk management. The optimal cash-capital ratio is seen as an endogenous value and should, according to the researchers, stand as a central enterprise policy. The value of the investment has an impact on the value of capital cash.
The recent financial crises (2008 and 2011) are proof that the situation at the financial market can change at any time. Business that does not have direct market exposure will also be affected. Campello (2010), Graham and Harvey (2010) show with their research, businesses that are currently in financial constraint will find it even more difficult to survive.
With this the researchers proof that these companies will need to cut back more than what they have originally planed for. In addition these companies liquidated their cash as well as drawing more credit from the bank; they also sold more assets than they would have done under normal conditions. The research of Bolton, Chen and Wang proof the significant risk factor on business which has a low capital cash balance. According to the research it is proven that we are facing a huge crisis.