Corporate Policies and the Term Structure of Risk

66 Pages Posted: 26 Jun 2020 Last revised: 29 Aug 2023

See all articles by Matthijs Breugem

Matthijs Breugem

University of Turin - Collegio Carlo Alberto

Roberto Marfè

University of Turin - Collegio Carlo Alberto

Francesca Zucchi

European Central Bank

Date Written: June 15, 2020

Abstract

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

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

Matthijs Breugem (Contact Author)

University of Turin - Collegio Carlo Alberto ( email )

Piazza Albarello 8
Torino, Torino 10122
Italy

Roberto Marfè

University of Turin - Collegio Carlo Alberto ( email )

Piazza Arbarello 8
Torino, Torino 10122
Italy

Francesca Zucchi

European Central Bank ( email )

Sonnemannstrasse 20
Frankfurt am Main, 60314
Germany

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