What Gives? A Study of Firms' Reactions to Cash Shortfalls

Abstract:     
This paper examines whether firms react to cash shortfalls by cutting investment. We use a regression discontinuity design in which the discontinuity is the point of violation of underfunding of corporate defined benefit pension plans. We reexamine the puzzling evidence in Rauh (2006) that mandatory pension contributions cause sharp investment declines, finding that these results are likely due to the endogeneity that this study is trying to avoid. We also compare firm-year observations in which the firm's pension assets are just barely less than its pension liabilities to observations in which assets are just greater than liabilities. In this quasi-experimental setting, we find little evidence that firms cut back on investment. Instead, they mostly use a variety of financial tools, such as receivables factoring and payout cuts, to fund their pension liabilities.

Number of Pages in PDF File: 42

Keywords: Investment, Regression Discontinuity, Endogeneity, Outliers

JEL Classification: G31, E22, G32

working papers series