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Corporate Demand for Liquidity

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  • Heitor Almeida
  • Murillo Campello
  • Michael S. Weisbach

Abstract

This paper proposes a theory of corporate liquidity demand and provides new evidence on corporate cash policies. Firms have access to valuable investment opportunities, but potentially cannot fund them with the use of external finance. Firms that are financially unconstrained can undertake all positive NPV projects regardless of their cash position, so their cash positions are irrelevant. In contrast, firms facing financial constraints have an optimal cash position determined by the value of today's investments relative to the expected value of future investments. The model predicts that constrained firms will save a positive fraction of incremental cash flows, while unconstrained firms will not. We also consider the impact of Jensen (1986) style overinvestment on the model's equilibrium, and derive conditions under which overinvestment affects corporate cash policies. We test the model's implications on a large sample of publicly-traded manufacturing firms over the 1981-2000 period, and find that firms classified as financially constrained save a positive fraction of their cash flows, while firms classified as unconstrained do not. Moreover, constrained firms save a higher fraction of cash inflows during recessions. These results are robust to the use of alternative proxies for financial constraints, and to several changes in the empirical specification. We also find weak evidence consistent with our agency-based model of corporate liquidity.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9253.

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Date of creation: Oct 2002
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Handle: RePEc:nbr:nberwo:9253

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Cited by:
  1. Halil Ibrahim Aydin & Cafer Kaplan & Mehtap Kesriyeli & Erdal Ozmen & Cihan Yalcin & Serkan Yigit, 2006. "Corporate Sector Financial Structure in Turkey : A Descriptive Analysis," Working Papers, Research and Monetary Policy Department, Central Bank of the Republic of Turkey 0607, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  2. Ozkan, Aydin & Ozkan, Neslihan, 2004. "Corporate cash holdings: An empirical investigation of UK companies," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(9), pages 2103-2134, September.
  3. Arun Khanna, 2004. "Corporate Investments, Liquidity and Bank Financing: Empirical Evidence from an Emerging Market," William Davidson Institute Working Papers Series, William Davidson Institute at the University of Michigan 2004-649, William Davidson Institute at the University of Michigan.
  4. Dasgupta, Sudipto & Sengupta, Kunal, 2007. "Corporate liquidity, investment and financial constraints: Implications from a multi-period model," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 16(2), pages 151-174, April.
  5. Ronald W. Anderson & Andrew Carverhill, 2005. "A model of corporate liquidity," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 24643, London School of Economics and Political Science, LSE Library.
  6. Roberto Álvarez & Andrés Sagner & Carla Valdivia, 2012. "Liquidity Crises and Corporate Cash Holdings in Chile," The Developing Economies, Institute of Developing Economies, Institute of Developing Economies, vol. 50(4), pages 378-392, December.
  7. Anderson, Ronald W & Carverhill, Andrew, 2005. "A Model of Corporate Liquidity," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4994, C.E.P.R. Discussion Papers.

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