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Temporary versus Permanent Shocks: Explaining Corporate Financial Policies

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  • Alexander S. Gorbenko

Abstract

We investigate corporate financial policies in the presence of both temporary and permanent shocks to firms' cash flows. In our framework, cash flows can be negative and are imperfectly correlated with firm value, and earnings volatility differs from asset volatility. These results are consistent with empirical stylized facts. They are also contrary to the implications of existing dynamic capital structure models that allow only for permanent shocks to cash flows. Temporary shocks increase the importance of financial flexibility and may provide an intuitively simple and realistic explanation of empirically observed financial conservatism and low leverage phenomena. The theoretical framework developed in this article general enough to be used in various corporate finance applications. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Suggested Citation

  • Alexander S. Gorbenko, 2010. "Temporary versus Permanent Shocks: Explaining Corporate Financial Policies," Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2591-2647, July.
  • Handle: RePEc:oup:rfinst:v:23:y:2010:i:7:p:2591-2647
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    File URL: http://hdl.handle.net/10.1093/rfs/hhq039
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    Cited by:

    1. Costas Lambrinoudakis & Michael Neumann & George Skiadopoulos, 2014. "Capital Structure and Financial Flexibility: Expectations of Future Shocks," Working Papers 731, Queen Mary University of London, School of Economics and Finance.
    2. Restrepo Ochoa, Diana C. & Correia, Ricardo & Peña, Juan Ignacio & Población, Javier, 2015. "Expropriation risk, investment decisions and economic sectors," Economic Modelling, Elsevier, vol. 48(C), pages 326-342.
    3. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
    4. Hugonnier, Julien & Malamud, Semyon & Morellec, Erwan, 2015. "Credit market frictions and capital structure dynamics," Journal of Economic Theory, Elsevier, vol. 157(C), pages 1130-1158.
    5. Décamps, Jean-Paul & Gryglewicz, S. & Morellec, E. & Villeneuve, Stéphane, 2015. "Corporate Policies with Temporary and Permanent Shocks," IDEI Working Papers 843, Institut d'Économie Industrielle (IDEI), Toulouse, revised Mar 2016.
    6. repec:eee:reveco:v:49:y:2017:i:c:p:292-312 is not listed on IDEAS
    7. Koetter, Michael & Noth, Felix & Rehbein, Oliver, 2016. "Borrowers under water! Rare disasters, regional banks, and recovery lending," IWH Discussion Papers 31/2016, Halle Institute for Economic Research (IWH).
    8. repec:eee:moneco:v:87:y:2017:i:c:p:13-33 is not listed on IDEAS
    9. Décamps, Jean Paul & Gryglewicz, Sebastian & Morellec, Erwan & Villeneuve, Stéphane, 2015. "Corporate policies with permanent and temporary shocks," CEPR Discussion Papers 10420, C.E.P.R. Discussion Papers.
    10. repec:cte:wbrepe:wb142304 is not listed on IDEAS

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