The Long and Short of Cash Flow Shocks and Debt Financing
65 Pages Posted: 14 Aug 2018 Last revised: 18 Nov 2019
Date Written: Novermber 15, 2019
We investigate how debt financing responds to exposure to long-lived and temporary cash flow shocks. We identify these shocks using filtering methods that we demonstrate are highly effective for corporate finance data using Monte-Carlo simulations. The long-lived and temporary shocks we identify for our sample of US firms have distinct economic roots. Consistent with predictions from theoretical models, we find that firms with higher relative exposure to long-lived cash flow shocks maintain higher leverage. Firms also issue more debt following cash flow increases arising from long-lived as opposed to temporary shocks. This link between cash flow shocks and debt financing is economically large and long-lived. It is primarily driven by profitable firms and stronger among less financially constrained firms.
Keywords: capital structure, permanent and transitory shocks
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