Corporate Money Demand

55 Pages Posted: 19 Apr 2018 Last revised: 30 Jun 2018

Xiaodan Gao

National University of Singapore

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Na Zhang

Fudan University - Department of Finance

Date Written: June 24, 2018

Abstract

We document a hump-shaped relation between interest rates and corporate cash balances. We rationalize this novel finding in a model where firms use internal cash and external debt to finance investment. Risky debt rates rise endogenously with the risk-free rate. Because firms accumulate cash to obtain better borrowing rates, optimal cash holdings also rise with the risk-free rate. However, income effects and foregone interest earnings imply a negative relation. The first mechanism dominates at low interest rates, while the second dominates at high interest rates. The model quantitatively matches several features of the data and reproduces the empirical hump-shaped cash-interest relation. The hump shape implies a modest welfare cost for low-inflation monetary policy. The quantitative model implies that interest rates cannot have been an important force behind the run-up in corporate cash balances since 1980.

Keywords: Corporate Cash Holdings, Interest Rates, Debt Cost, Financial Frictions

JEL Classification: E41, E43, G12, G32

Suggested Citation

Gao, Xiaodan and Whited, Toni M. and Zhang, Na, Corporate Money Demand (June 24, 2018). Available at SSRN: https://ssrn.com/abstract=3165532 or http://dx.doi.org/10.2139/ssrn.3165532

Xiaodan Gao

National University of Singapore ( email )

15 Kent Ridge Drive
Mochtar Riady Building, #6-50
Singapore, Singapore 119245
Singapore
(+65)66013543 (Phone)
(+65)67795059 (Fax)

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Na Zhang

Fudan University - Department of Finance ( email )

Shanghai, 200433
China

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