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Precautionary Corporate Liquidity


Chen, Kaiji; Song, Zheng; Wang, Yikai (2010). Precautionary Corporate Liquidity. Working paper series / Institute for Empirical Research in Economics No. 465, University of Zurich.

Abstract

We develop a theory of corporate liquidity demand, capturing the fact that a firm'snborrowing 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.

We develop a theory of corporate liquidity demand, capturing the fact that a firm'snborrowing 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.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:January 2010
Deposited On:29 Nov 2011 15:09
Last Modified:05 Apr 2016 15:08
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
Official URL:http://www.econ.uzh.ch/wp.html
Permanent URL: https://doi.org/10.5167/uzh-51726

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