Agency, Corporate Liquidity, and Optimal Investment Horizon

57 Pages Posted: 27 Apr 2022

See all articles by Tak-Yuen Wong

Tak-Yuen Wong

National Tsing Hua University - Department of Quantitative Finance

Siqi Zhao

Shanghai University of Finance and Economics

Date Written: April 13, 2022

Abstract

We develop a liquidity management model with dynamic agency. The agent controls short-term investment, which affects the current profitability, and long-term investment, which determines the firm growth. Regardless of the correlation between transitory cash flow and permanent growth shocks, the optimal contract implements excessive short-term investment, leading to corporate short-termism. Our model predicts that distressed firms behave more short-termist and firms with a higher correlation between shocks implement riskier and longer-term policies. Moreover, the cash-flow sensitivity of cash is non-monotonic in agency frictions and levered firms may shift cash flow risk from the agent to creditors, mitigating overinvestment in short term.

Keywords: optimal contract, liquidity management, short-termism

JEL Classification: D86, G31, G32

Suggested Citation

Wong, Tak-Yuen and Zhao, Siqi, Agency, Corporate Liquidity, and Optimal Investment Horizon (April 13, 2022). Available at SSRN: https://ssrn.com/abstract=4082534 or http://dx.doi.org/10.2139/ssrn.4082534

Tak-Yuen Wong (Contact Author)

National Tsing Hua University - Department of Quantitative Finance ( email )

101, Section 2, Kuang-Fu Road
Hsinchu, Taiwan 300
Taiwan

HOME PAGE: http://https://sites.google.com/site/etywong110/

Siqi Zhao

Shanghai University of Finance and Economics

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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