DP15059 The Sensitivity of Cash Savings to the Cost of Capital

Author(s): Viral V. Acharya, Soku Byoun, Zhaoxia Xu
Publication Date: July 2020
Keyword(s): Financial constraint, Hedging, market timing, Precautionary motive
JEL(s): G32, G35
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15059

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.