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Precautionary corporate liquidity

Kaiji Chen, Zheng Song and Yikai Wang

No 465, IEW - Working Papers from Institute for Empirical Research in Economics - University of Zurich

Abstract: We develop a theory of corporate liquidity demand, capturing the fact that a firm's borrowing capacity depends on news on future investment profitability. In our model, bad news on future investment profitability reduces a firm's borrowing capacity and therefore increases the need for internal finance. Consequently, the firm's cash savings respond negatively to news on future profitability. This negative correlation is strongly supported by our empirical evidence using a combined data set of Compustat and IBES. Moreover, both our simulation and empirical results show that the sensitivity of cash savings to news on future profitability is a reliable indicator of the presence of financial constraints at firm level.

Keywords: News; financial constraint; corporate savings (search for similar items in EconPapers)
JEL-codes: G3 (search for similar items in EconPapers)
Date: 2010-01
New Economics Papers: this item is included in nep-bec
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