Discussion Paper Details

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Title: The Sensitivity of Cash Savings to the Cost of Capital

Author(s): Viral V. Acharya, Soku Byoun and Zhaoxia Xu

Publication Date: July 2020

Keyword(s): Financial constraint, Hedging, market timing and Precautionary motive

Programme Area(s): Financial Economics

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.

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Bibliographic Reference

Acharya, V, Byoun, S and Xu, Z. 2020. 'The Sensitivity of Cash Savings to the Cost of Capital'. London, Centre for Economic Policy Research.