Transitory versus Permanent Shocks: Explaining Corporate Savings and Investment
63 Pages Posted: 26 Jun 2017 Last revised: 15 Mar 2018
Date Written: July 11, 2017
We model the investment and cash policies of a firm facing financing frictions, transitory cash flow shocks, and permanent productivity shocks. While cash holdings increase and investment and Tobin's $q$ decrease with the volatilities of either type of shocks, a higher correlation between these shocks makes the firm hold less cash, invest more, and become more valuable. We verify these predictions on a large sample of U.S. firms using estimates of permanent and transitory cash flow shocks obtained via structural estimation. Our results suggest that corporate policies and valuations are better understood when distinguishing between permanent and transitory cash flow shocks.
Keywords: Cash holdings, Investment, permanent vs. transitory shocks
JEL Classification: G31, G32, G35
Suggested Citation: Suggested Citation