Precautionary Corporate Liquidity
Univ. of Zurich Working Paper No. 465
24 Pages Posted: 20 Feb 2010
Date Written: February 14, 2009
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: Suggested Citation