Corporate Money Demand
55 Pages Posted: 19 Apr 2018 Last revised: 30 Jun 2018
Date Written: June 24, 2018
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: Suggested Citation