The Effect of Financing Frictions on Firm Cash Policy, Cash Flows and Risk Premium

44 Pages Posted: 4 Jun 2010

See all articles by Huidan Lin

Huidan Lin

International Monetary Fund

Daniel Paravisini

London School of Economics & Political Science (LSE)

Date Written: June 1, 2010

Abstract

Consistent with precautionary savings models, we provide evidence that firms hoard cash in response to an exogenous credit shortage. For identification, we compare public U.S. firms in the same industry, location, and size quintile, but whose access to bank credit was differentially affected around WorldCom’s demise in 2002. The credit shortage induces a decrease in the level of cash flows, and an increase in their volatility and skewness. It also increases the covariance of stock returns with the market. The overall results suggest that financing frictions increase firms’ likelihood of financial distress and risk premium.

Keywords: Credit constraints, financial policy, cash management, risk premium, investment

JEL Classification: G32, G31

Suggested Citation

Lin, Huidan and Paravisini, Daniel, The Effect of Financing Frictions on Firm Cash Policy, Cash Flows and Risk Premium (June 1, 2010). Available at SSRN: https://ssrn.com/abstract=1594121 or http://dx.doi.org/10.2139/ssrn.1594121

Huidan Lin

International Monetary Fund ( email )

700 19th Street
Washington D.C., DC 20431
United States

Daniel Paravisini (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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