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A theory of corporate financial decisions with liquidity and solvency concerns

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  • Gryglewicz, Sebastian

Abstract

This paper studies the impact of both liquidity and solvency concerns on corporate finance. I present a tractable model of a firm that optimally chooses capital structure, cash holdings, dividends, and default while facing cash flows with long-term uncertainty and short-term liquidity shocks. The model explains how changes in solvency affect liquidity and also how liquidity concerns affect solvency via capital structure choice. These interactions result in a dynamic cash policy in which cash reserves increase in profitability and are positively correlated with cash flows. The optimal dividend distributions implied by the model are smoothed relative to cash flows. I also find that liquidity concerns lead to a decrease of dispersion of credit spreads.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 99 (2011)
Issue (Month): 2 (February)
Pages: 365-384

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Handle: RePEc:eee:jfinec:v:99:y:2011:i:2:p:365-384

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Web page: http://www.elsevier.com/locate/inca/505576

Related research

Keywords: Financial distress Capital structure Cash holdings Dividends Financing constraints;

References

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Citations

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Cited by:
  1. Mónika Kuti, 2011. "Cash Flow at Risk, Financial Flexibility and Financing Constraint," Public Finance Quarterly, State Audit Office of Hungary, vol. 56(4), pages 505-517.
  2. Rashid Ameer, 2012. "Impact of cash holdings and ownership concentration on firm valuation: Empirical evidence from Australia," Review of Accounting and Finance, Emerald Group Publishing, vol. 11(4), pages 448-467.
  3. Viral V. Acharya & Sergei A. Davydenko & Ilya A. Strebulaev, 2011. "Cash Holdings and Credit Risk," NBER Working Papers 16995, National Bureau of Economic Research, Inc.
  4. Bhaumik, Sumon Kumar & Das, Pranab Kumar & Kumbhakar, Subal C., 2012. "A stochastic frontier approach to modelling financial constraints in firms: An application to India," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1311-1319.
  5. Sumon Bhaumik & Pranab Kumar Das & Subal C. Kumbhakar, 2011. "Firm Investment & Credit Constraints in India, 1997 – 2006: A stochastic frontier approach," William Davidson Institute Working Papers Series wp1010, William Davidson Institute at the University of Michigan.

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