The Sensitivity of Cash Savings to the Cost of Capital
69 Pages Posted: 19 Aug 2020 Last revised: 27 Jan 2022
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The Sensitivity of Cash Savings to the Cost of Capital
The Sensitivity of Cash Savings to the Cost of Capital
The Sensitivity of Cash Savings to the Cost of Capital
Date Written: June 30, 2020
Abstract
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