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Costly External Finance, Corporate Investment, and the Subprime Mortgage Credit Crisis

47 Pages Posted: 18 Oct 2008 Last revised: 6 Dec 2009

Ran Duchin

University of Washington - Michael G. Foster School of Business

Oguzhan Ozbas

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Berk A. Sensoy

Vanderbilt University - Finance

Date Written: August 28, 2009

Abstract

We study the effect of the recent financial crisis on corporate investment. The crisis represents an unexplored negative shock to the supply of external finance for non-financial firms. Corporate investment declines significantly following the onset of the crisis, controlling for firm fixed effects and time-varying measures of investment opportunities. Consistent with a causal effect of a supply shock, the decline is greatest for firms that have low cash reserves or high net short-term debt, are financially constrained, or operate in industries dependent on external finance. To address endogeneity concerns, we measure firms’ financial positions as much as four years prior to the crisis, and confirm that similar results do not follow placebo crises in the summers of 2003–2006. Nor do similar results follow the negative demand shock caused by September 11, 2001. The effects weaken considerably beginning in the third quarter of 2008, when the demand-side effects of the crisis became apparent. Additional analysis suggests an important precautionary savings motive for seemingly excess cash that is generally overlooked in the literature.

Keywords: Corporate Investment, Cash, Corporate Liquidity, Financing Constraints, Crisis

JEL Classification: G01, G31, G32

Suggested Citation

Duchin, Ran and Ozbas, Oguzhan and Sensoy, Berk A., Costly External Finance, Corporate Investment, and the Subprime Mortgage Credit Crisis (August 28, 2009). Journal of Financial Economics (JFE), Forthcoming; Marshall School of Business Working Paper No. MKT 01-09; Ross School of Business Paper No. 1121. Available at SSRN: https://ssrn.com/abstract=1286204

Ran Duchin

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Oguzhan Ozbas (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-0781 (Phone)
213-740-6650 (Fax)

Berk Sensoy

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States

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