Corporate Policies and the Term Structure of Risk

Asset pricing research indicates that the long and short term do not contribute equally to the market risk premium, and that their relative contribution is time-varying. While having notable implications for firm discount rates, corporate finance models typically abstract from these aspects. In a dynamic model with financing frictions, we show that firms should extend (shorten) their horizon if short-term shocks have a greater (smaller) market price than long-term ones, i.e., if the term structure of risk prices is downward-sloping (upward-sloping). Ignoring a downward-sloping term structure leads to underinvestment, excessive payouts, inadequate cash reserves and equity issuances, and excessive liquidations.

Keywords: Horizon of corporate policies; Term structure of risk; Temporary vs.\ permanent shocks

JEL Classification: G12, G31, G32, G35

Suggested Citation: Suggested Citation

Breugem, Matthijs and Marfè, Roberto and Zucchi, Francesca, Corporate Policies and the Term Structure of Risk (June 15, 2020). Available at SSRN: https://ssrn.com/abstract=3601718 or http://dx.doi.org/10.2139/ssrn.3601718