The Influence of Investment Volatility on Capital Structure and Cash Holdings

Abstract

This paper studies the relationship between investment volatility, capital structure, and cash levels. Our evidence suggests: i) firms with relatively high realizations of future investment volatility hold relatively low levels of debt and high levels of cash, ii) firms fund large investment by increasing (issuing) debt and/or decreasing (using) cash, iii) immediately after funding large investments firms reduce debt levels and increase cash holdings. Overall, our results are consistent with the DeAngelo, DeAngelo, and Whited (2011) model. In particular, firms with high realizations of future investment volatility keep their debt levels low and cash levels high to finance uncertain future investments.

Keywords: capital structure, cash holding and investment volatility

JEL Classification: G32