53 Pages Posted: 7 Nov 2006 Last revised: 5 Feb 2012
Date Written: July 8, 2007
Why and how do corporations accumulate liquid assets? We show theoretically that intertemporal trade-offs between interest income taxation and the cost of external finance determine optimal savings. We find the striking result that, controlling for Tobin's q, saving and cash flow are negatively related because firms lower cash reserves to invest after receiving positive cash-flow shocks, and vice versa. Consistent with theory, we estimate negative propensities to save out of cash flow. We also find that income uncertainty affects saving more than do external finance constraints. Therefore, contrary to previous evidence, saving propensities reflect too many individual forces to be used to measure external finance constraints.
Keywords: Corporate saving, cash, investment, costly external finance, uncertainty
JEL Classification: G31, G32, E22
Suggested Citation: Suggested Citation