Financial distress, inter-firm payment network and free cash flow target: An agent-based approach

This paper is a contribution to the understanding of financial distress in the business sector, in line with the literature on the financial causes of macroeconomic instability. The paper studies the impact of free cash flow targets on the financial distress of firms, given the influence of free cash flow targets on customer–supplier relationships, available cash, and indebtedness in the business sector. The paper leverages an agent-based macroeconomic setting inspired by monetary analysis à la Schumpeter. The core of the model is the complex network of payments that connect firms according to decentralized interactions. Free cash flow targets depend on the past accumulation of cash jointly with sales expectations. Inter-firm payment networks arise not only from uniform attachment mechanisms but also from preferential attachment mechanisms. We conduct computational experiments in which firms target different levels of free cash flow and assess the subsequent effects on financial distress. The parameters of the model are calibrated to make the simulations compatible with fundamental macroeconomic stylized facts regarding growth, short-term fluctuations, and wealth. Simulations of the model suggest that if firms are ready to accept lower free cash flow targets as they make more expenditures for a given level of net cash balances, then the level of financial distress tends to be lower. This result is discussed in relation to the weakening of the “retain and reinvest” strategy within the historical context of financialization. The paper concludes that firms’ micro-decisions regarding free cash flows have far-reaching consequences at the macroeconomic level.