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

42 Pages Posted: 2 Nov 2008 Last revised: 9 Nov 2008

See all articles by Tor-Erik Bakke

Tor-Erik Bakke

University of Illinois at Chicago - Department of Finance

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: November 6, 2008

Abstract

This paper examines the relative magnitude of financial versus real frictions by looking at how firms react to cash shortfalls. 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 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.

Keywords: investment, finance constraints, regression discontinuity, outliers

JEL Classification: C21, D92, E22, G31

Suggested Citation

Bakke, Tor-Erik and Whited, Toni M., What Gives? A Study of Firms' Reactions to Cash Shortfalls (November 6, 2008). Available at SSRN: https://ssrn.com/abstract=1293486 or http://dx.doi.org/10.2139/ssrn.1293486

Tor-Erik Bakke

University of Illinois at Chicago - Department of Finance ( email )

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Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

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National Bureau of Economic Research ( email )

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