Corporate Policies and the Term Structure of Risk

Abstract

We build a dynamic corporate finance model with heterogeneity in the pricing and in the firm's exposure to aggregate risks. All else equal, we show that if long-term (persistent) shocks have a higher market price than short-term (temporary) shocks, firms shorten the horizon of corporate policies, favoring payouts over investment. In the cross section, this effect is stronger for firms more exposed to long-term shocks, but can be reversed for firms more exposed to short-term shocks. Our analysis is extended to embed time variation in risk prices over the business cycle, motivated by recent evidence on the term structure of equity.

Keywords: Temporary vs. permanent shocks, Pricing of aggregate risks, Horizon of corporate policies

JEL Classification: G12, G31, G32