Temporary vs. Permanent Shocks: Explaining Corporate Financial Policies

67 Pages Posted: 5 Aug 2009

See all articles by Alexander S. Gorbenko

Alexander S. Gorbenko

University College London - Department of Economics and School of Management

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: Febaruary 3, 2009

Abstract

We investigate corporate financial policies in the presence of both temporary and permanent shocks to firms' cash flows. In our framework firms can experience negative cash flows, the changes in and levels of cash flows are imperfectly correlated with firm value, and earnings volatility is different from asset volatility. These results are consistent with empirical stylized facts and are opposite to the implications of existing dynamic capital structure models which allow only for permanent shocks to cash flows. Our results show that temporary shocks increase the importance of financial flexibility and may provide an intuitively simple and realistic explanation of empirically observed financial conservatism and low leverage phenomena. The theoretical framework developed in this paper is general enough to be used in various corporate finance applications.

Keywords: Leverage, debt financing, capital structure, financing decisions, temporary and permanent shocks, mean-reversion, finance substitution

JEL Classification: G12, G32, G33

Suggested Citation

Gorbenko, Alexander S. and Strebulaev, Ilya A., Temporary vs. Permanent Shocks: Explaining Corporate Financial Policies (Febaruary 3, 2009). Available at SSRN: https://ssrn.com/abstract=1352723 or http://dx.doi.org/10.2139/ssrn.1352723

Alexander S. Gorbenko

University College London - Department of Economics and School of Management ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

Ilya A. Strebulaev (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
336
Abstract Views
2,064
rank
106,871
PlumX Metrics