The Sensitivity of Cash Savings to the Cost of Capital
68 Pages Posted: 28 Jul 2020 Last revised: 16 Aug 2020
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The Sensitivity of Cash Savings to the Cost of Capital
The Sensitivity of Cash Savings to the Cost of Capital
Date Written: July 2020
Abstract
We show theoretically and empirically that in the presence of a time-varying cost
of capital (COC), firms have a hedging motive to reduce the overall COC over time
by saving cash when COC is relatively low. The sensitivity of cash savings to COC
is especially pronounced with respect to the cost of equity and for firms with greater
correlation between COC and financing needs for future investments. Both financially
constrained and unconstrained firms respond to low COC by saving cash out of external
capital issuance in excess of current financial needs.
Keywords: Financial constraint, Hedging, market timing, Precautionary motive
JEL Classification: G32, G35
Suggested Citation: Suggested Citation