DP15059 The Sensitivity of Cash Savings to the Cost of Capital

• Viral Acharya Soku Byoun Zhaoxia Xu
17 Jul 2020

We theoretically and empirically show that in the presence of a time-varying cost of capital
(COC), firms save from external capital when the firm-specific COC is low to hedge against
the risk of underinvestment due to a higher COC in the future. This hedging motive drives
the sensitivity of cash saving to the COC in both financially constrained and currently unconstrained
firms. This sensitivity is especially pronounced among firms that tend to face a
higher COC when in need of external finance. These firms with high hedging motives issue
excess capital to save cash when the COC is lower. Such cash saving behavior is influenced by
future investments.