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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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    File URL: https://www.zora.uzh.ch/id/eprint/51726/1/iewwp465.pdf
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    References listed on IDEAS

    as
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    • G3 - Financial Economics - - Corporate Finance and Governance

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