Working Paper: CEPR ID: DP14017
Authors: Refet S. Grkaynak; Sang Seok Lee; Gokce Karasoy
Abstract: We show that firm liability structure and associated cash flow matter for firm behavior, and that financial market participants price stocks accordingly. Looking at firm level stock price changes around monetary policy announcements, we find that firms that have more cash flow exposure see their stock prices affected more. The stock price reaction depends on the maturity and type of debt issued by the firm, and the forward guidance provided by the Fed. This effect has remained intact during the ZLB period. Importantly, we show that the effect is not a rule of thumb behavior outcome and that the marginal stock market participant actually studies and reacts to the liability structure of firm balancesheets. The cash flow exposure at the time of monetary policy actions predicts future net worth, investment, and assets, verifying the stock pricing decision and also providing evidence of cash flow effects on firms' real behavior. The results hold for S&P500 firms that are usually thought of not being subject to tight financial constraints.
Keywords: cash flow effect; monetary policy; investor sophistication; financial frictions; stock pricing
JEL Codes: E43; E44; E52; E58; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy surprises (E39) | stock prices (G12) |
| cash flow exposure (F31) | stock prices (G12) |
| contractionary monetary policy surprises (E52) | stock prices (G12) |
| cash flow exposure + monetary policy surprises (E50) | stock prices (G12) |
| liability structure (G32) | stock prices (G12) |
| monetary policy tightening (E63) | net worth (G19) |
| monetary policy tightening (E63) | capital investment (E22) |
| cash flow exposure + unhedged floating rate debt (G19) | stock prices (G12) |