Productivity and Liquidity Management Under Costly Financing
59 Pages Posted: 15 Dec 2015 Last revised: 16 Dec 2017
Date Written: May 25, 2017
We explore theoretically and empirically the relationship between firm productivity and liquidity management in the presence of financial frictions. We build a dynamic investment model and show that, counter to basic economic intuition, more productive firms could demand less capital assets and hold more liquid assets compared to less productive firms when financing costs are sufficiently high. We empirically test this prediction using a comprehensive dataset of Chinese manufacturers and find that more productive firms indeed hold less capital and more cash. We do not, however, observe this for U.S. manufacturers. Our study suggests a larger capital misallocation problem in markets with significant financing frictions than previously documented.
Keywords: Liquidity management, cash holding, productivity, emerging economy
JEL Classification: G31, G32, G11, G15
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