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Precautionary corporate liquidity

Author

Listed:
  • Kaiji Chen
  • Zheng Song
  • Yikai Wang

Abstract

We develop a theory of corporate liquidity demand, capturing the fact that a firm's borrowing capacity depends on news on future investment profitability. In our model, bad news on future investment profitability reduces a firm's borrowing capacity and therefore increases the need for internal finance. Consequently, the firm's cash savings respond negatively to news on future profitability. This negative correlation is strongly supported by our empirical evidence using a combined data set of Compustat and IBES. Moreover, both our simulation and empirical results show that the sensitivity of cash savings to news on future profitability is a reliable indicator of the presence of financial constraints at firm level.

Suggested Citation

  • Kaiji Chen & Zheng Song & Yikai Wang, 2010. "Precautionary corporate liquidity," IEW - Working Papers 465, Institute for Empirical Research in Economics - University of Zurich.
  • Handle: RePEc:zur:iewwpx:465
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    References listed on IDEAS

    as
    1. Urban J. Jermann & Vincenzo Quadrini, 2006. "Financial innovations and macroeconomic volatility," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
    2. Steven M. Fazzari & Bruce C. Petersen, 1993. "Working Capital and Fixed Investment: New Evidence on Financing Constraints," RAND Journal of Economics, The RAND Corporation, vol. 24(3), pages 328-342, Autumn.
    3. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 1027-1057, October.
    4. Vlieghe, Gertjan & Stephen Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed, 2003. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," Royal Economic Society Annual Conference 2003 212, Royal Economic Society.
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    8. Leigh A. Riddick & Toni M. Whited, 2009. "The Corporate Propensity to Save," Journal of Finance, American Finance Association, vol. 64(4), pages 1729-1766, August.
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    11. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
    12. Andrew Atkeson & Patrick J. Kehoe, 2002. "The transition to a new economy after the Second Industrial Revolution," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
    13. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 169-215.
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    More about this item

    Keywords

    News; financial constraint; corporate savings;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance

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