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Corporate Liquidity and Capital Structure

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  • Ronald W. Anderson
  • Andrew Carverhill

Abstract

We solve for a firm's optimal cash holding policy within a continuous time, contingent claims framework using dividends, short-term borrowing, and equity issues as controls assuming mean reversion of earnings. Optimal cash is non-monotone in business conditions and increasing in the level of long-term debt. The model matches closely a wide range of empirical benchmarks and predicts cash and leverage dynamics in line with the empirical literature. Firm value is quite insensitive to changes in the level of long-term debt. The model has interesting implications for asset substitution, hedging, and pecking order. Growth opportunities do not greatly affect cash holding policy. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Ronald W. Anderson & Andrew Carverhill, 2012. "Corporate Liquidity and Capital Structure," Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 797-837.
  • Handle: RePEc:oup:rfinst:v:25:y:2012:i:3:p:797-837
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    File URL: http://hdl.handle.net/10.1093/rfs/hhr103
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    1. repec:eee:jbfina:v:81:y:2017:i:c:p:221-235 is not listed on IDEAS
    2. Max Reppen & Jean-Charles Rochet & H. Mete Soner, 2017. "Dividends with random profitability rate," Papers 1706.01813, arXiv.org, revised Jul 2017.
    3. repec:eee:jfinec:v:124:y:2017:i:2:p:395-414 is not listed on IDEAS
    4. Arnold, Marc, 2014. "Managerial cash use, default, and corporate financial policies," Journal of Corporate Finance, Elsevier, vol. 27(C), pages 305-325.
    5. Patrick Bolton & Neng Wang & Jinqiang Yang, 2014. "Investment Under Uncertainty and the Value of Real and Financial Flexibility," NBER Working Papers 20610, National Bureau of Economic Research, Inc.
    6. Anderson, Ronald W. & Hamadi, Malika, 2016. "Cash holding and control-oriented finance," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 410-425.
    7. Bakke, Tor-Erik & Gu, Tiantian, 2017. "Diversification and cash dynamics," Journal of Financial Economics, Elsevier, vol. 123(3), pages 580-601.
    8. repec:eee:jfinec:v:125:y:2017:i:2:p:344-368 is not listed on IDEAS
    9. 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.
    10. Juliane Begenau & Berardino Palazzo, 2017. "Firm Selection and Corporate Cash Holdings," NBER Working Papers 23249, National Bureau of Economic Research, Inc.
    11. Koussis, Nicos & Martzoukos, Spiros H. & Trigeorgis, Lenos, 2017. "Corporate liquidity and dividend policy under uncertainty," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 200-214.
    12. Benson, Karen & Faff, Robert & Smith, Tom, 2015. "Injecting liquidity into liquidity research," Pacific-Basin Finance Journal, Elsevier, pages 533-540.
    13. Elnahas, Ahmed M. & Hassan, M. Kabir & Ismail, Ghada M., 2017. "Religion and ratio analysis: Towards an Islamic corporate liquidity measure," Emerging Markets Review, Elsevier, vol. 30(C), pages 42-65.
    14. Marti G. Subrahmanyam & Dragon Yongjun Tang & Sarah Qian Wang, 2016. "Credit Default Swaps, Exacting Creditors and Corporate Liquidity Management," Working Papers 202016, Hong Kong Institute for Monetary Research.
    15. García Cabello, Julia, 2017. "The future of branch cash holdings management is here: New Markov chains," European Journal of Operational Research, Elsevier, vol. 259(2), pages 789-799.
    16. Francis A. Longstaff & Ilya A. Strebulaev, 2014. "Corporate Taxes and Capital Structure: A Long-Term Historical Perspective," NBER Working Papers 20372, National Bureau of Economic Research, Inc.

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