Working Paper: CEPR ID: DP10420
Authors: Jean Paul Decamps; Sebastian Gryglewicz; Erwan Morellec; Stéphane Villeneuve
Abstract: We develop a dynamic model of investment, cash holdings, financing, and risk management policies in which firms face financing frictions and are subject to permanent and temporary cash flow shocks. In this model, target cash holdings depend on the long-term prospects of the firm, implying that the payout policy of the firm, its financing policy, and its cash-flow sensitivity of cash display a more realistic behavior than in prior models with financing frictions. In addition, risk management policies are richer and depend on the nature of cash flow shocks and potential collateral constraints. Lastly, the timing of investment and the firm?s initial asset mix both reflect financing frictions and the joint effects of permanent and temporary shocks.
Keywords: Corporate policies; Financing frictions; Permanent vs temporary shocks; Risk management
JEL Codes: G31; G32; G35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financing frictions and temporary shocks (E44) | delay investment decisions (D25) |
| temporary shocks (E32) | larger cash balances at investment time (G31) |
| permanent shocks (E32) | target cash holdings (G19) |
| permanent shocks (E32) | hoard more cash (D14) |
| negative shocks (F69) | decrease cash reserves (G21) |
| permanent shocks (E32) | increase firm value (L21) |
| permanent shocks (E32) | decrease target cash holdings (E41) |
| permanent shocks (E32) | cash flow sensitivity of cash (E41) |
| permanent shocks (E32) | size of equity issues (G12) |