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Free cash flow, issuance costs, and stock prices


Rochet, Jean-Charles; Mariotti, Thomas; Décamps, Jean-Paul; Villeneuve, Stéphane (2011). Free cash flow, issuance costs, and stock prices. Journal of Finance, 66(5):1501-1544.

Abstract

We develop a dynamic model of a firm facing agency costs of free cash flow and externalfinancing costs, and derive an explicit solution for the firm’s optimal balance sheet dynamics. Financial frictions affect issuance and dividend policies, the value of cash holdings, and the dynamics of stock prices. The model predicts that the marginal value of cash varies negatively with the stock price, and positively with the volatility of the stock price. This yields novel insights on the asymmetric volatility phenomenon, on risk management policies, and on how business cycles and agency costs affect the volatility of stock returns.

Abstract

We develop a dynamic model of a firm facing agency costs of free cash flow and externalfinancing costs, and derive an explicit solution for the firm’s optimal balance sheet dynamics. Financial frictions affect issuance and dividend policies, the value of cash holdings, and the dynamics of stock prices. The model predicts that the marginal value of cash varies negatively with the stock price, and positively with the volatility of the stock price. This yields novel insights on the asymmetric volatility phenomenon, on risk management policies, and on how business cycles and agency costs affect the volatility of stock returns.

Citations

13 citations in Web of Science®
17 citations in Scopus®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Date:2011
Deposited On:16 Jan 2012 14:15
Last Modified:05 Apr 2016 15:20
Publisher:Wiley-Blackwell
ISSN:0022-1082
Publisher DOI:https://doi.org/10.1111/j.1540-6261.2011.01680.x
Official URL:http://www.afajof.org/afa/forthcoming/6519.pdf
Other Identification Number:merlin-id:6040

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