Financial Slack: A Strategic Control Decision

Abstract

Financial slack or debt capacity adds to the discretion of managers. For strategic reasons, this discretion is valuable in the event of unforeseen future investment opportunities. This paper investigates how this strategic allocation of control within the firm influences the choice among short-term debt, long-term debt, and equity. This analysis suggests that equity or long-term debt produces efficient investment decisions when relationship-specific assets exist and are unequally distributed. Otherwise, non-integration via short-term debt is preferred.