The Sensitivity of Cash Savings to the Cost of Capital
69 Pages Posted: 19 Aug 2020 Last revised: 27 Jan 2022
Date Written: June 30, 2020
We theoretically and empirically show that in the presence of a time-varying cost of capital (COC), firms save cash from external capital when the firm-specific COC is low to hedge against the risk of underinvestment in the future from a higher COC. This hedging motive drives the sensitivity of cash savings to the COC in both financially constrained and currently unconstrained firms. This sensitivity is especially pronounced among firms with a stronger correlation between their COC and financing needs for future investments. These results cannot be fully explained by the alternative motives for cash documented in the literature.
Keywords: Hedging, Precautionary Motive, Market Timing, Financial Constraint
JEL Classification: G32, G35
Suggested Citation: Suggested Citation