Precautionary Corporate Liquidity

Univ. of Zurich Working Paper No. 465

24 Pages Posted: 20 Feb 2010  

Kaiji Chen

Emory University - Department of Economics; Federal Reserve Bank of Atlanta

Zheng Michael Song

Fudan University - School of Economics

Yikai Wang

University of Zurich

Date Written: February 14, 2009

Abstract

We develop a theory of corporate liquidity demand, capturing the fact that a firm's borrowing capacity depends on news on future investment profitability. In our model, bad news on future investment profitability reduces a firm's borrowing capacity and therefore increases the need for internal finance. Consequently, the firm's cash savings respond negatively to news on future profitability. This negative correlation is strongly supported by our empirical evidence using a combined data set of Compustat and IBES. Moreover, both our simulation and empirical results show that the sensitivity of cash savings to news on future profitability is a reliable indicator of the presence of financial constraints at firm level.

Keywords: News, Financial Constraint, Corporate Savings

JEL Classification: G3

Suggested Citation

Chen, Kaiji and Song, Zheng Michael and Wang, Yikai, Precautionary Corporate Liquidity (February 14, 2009). Univ. of Zurich Working Paper No. 465. Available at SSRN: https://ssrn.com/abstract=1554843 or http://dx.doi.org/10.2139/ssrn.1554843

Kaiji Chen (Contact Author)

Emory University - Department of Economics ( email )

1602 Fishburne Drive
Atlanta, GA 30322
United States

HOME PAGE: http://https://sites.google.com/site/chenkaiji/research

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Zheng Song

Fudan University - School of Economics ( email )

600 GuoQuan Road
Shanghai, 200433
China

Yikai Wang

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

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