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Precautionary Saving in a Financially Constrained Firm

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  • Andrew B Abel
  • Stavros Panageas

Abstract

For a firm that cannot raise external funds, cash on hand serves as precautionary saving. We derive a closed-form expression for the target level of cash on hand in the presence of persistent cash flows. Contrary to conventional wisdom, a mean-preserving increase in the volatility of cash flow can decrease this target. Over the set of admissible parameter values, the average impact of volatility on the target is zero. Endogenous selection, reflecting termination of firms that run out of cash, leads to a positive average impact of volatility on the target level of cash, consistent with empirical findings.

Suggested Citation

  • Andrew B Abel & Stavros Panageas, 2023. "Precautionary Saving in a Financially Constrained Firm," The Review of Financial Studies, Society for Financial Studies, vol. 36(7), pages 2878-2921.
    • Handle: RePEc:oup:rfinst:v:36:y:2023:i:7:p:2878-2921.
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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