DP10420 Corporate policies with permanent and temporary shocks

Author(s): Jean Paul Décamps, Sebastian Gryglewicz, Erwan Morellec, Stéphane Villeneuve
Publication Date: February 2015
Keyword(s): corporate policies, financing frictions, permanent vs. temporary shocks, risk management
JEL(s): G31, G32, G35
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10420

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.