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

42 Pages Posted: 10 Jan 2009

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: January 9, 2009

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.

Keywords: Investment, Regression Discontinuity, Endogeneity, Outliers

JEL Classification: G31, E22, G32

Suggested Citation

Bakke, Tor-Erik and Whited, Toni M., What Gives? A Study of Firms' Reactions to Cash Shortfalls (January 9, 2009). EFA 2009 Bergen Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1325582 or http://dx.doi.org/10.2139/ssrn.1325582

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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