34 Pages Posted: 13 Jan 2012 Last revised: 21 May 2014
Date Written: May 2014
We use firms' decisions in the cross-section about their sources and uses of funds in order to make inferences about the aggregate cost of external finance. The basic intuition is as follows: Firms which raise costly external finance can invest the issuance proceeds in productive capital assets, or in liquid financial assets with a low physical rate of return. If firms raise costly external finance and allocate some of the funds to liquid assets, either the cost of external finance is relatively low, or the total return to liquidity accumulation, including its value as a hedging asset, is particularly high. We construct and estimate a quantitative, dynamic model of firms' financing and savings decisions. We then use the model's predictions for variation in firm policies and implied cross sectional moments, along with empirical moments from Compustat, to infer the average cost of external finance per dollar raised in the US time series 1980-2010.
Keywords: liquidity management, external finance
JEL Classification: G31, G32, E22
Suggested Citation: Suggested Citation