Composition of Cash Flow Shocks and Debt Financing
60 Pages Posted: 14 Aug 2018 Last revised: 17 Jan 2019
Date Written: December 18, 2018
We investigate empirically how exposure to long-lived and temporary shocks to firm cash flows affects debt financing. We identify persistent and temporary cash flow shocks using filtering methods, and demonstrate these methods are highly effective for corporate finance data using Monte-Carlo simulations. Our empirical estimates indicate that firms with higher relative exposure to persistent cash flow shocks maintain higher leverage, consistent with existing theoretical implications. Furthermore, firms issue more debt following higher cash flows attributable to persistent 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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