Hostname: page-component-76fb5796d-x4r87 Total loading time: 0 Render date: 2024-04-29T20:48:41.129Z Has data issue: false hasContentIssue false
  • English
  • Français

The Determinants of Corporate Liquidity: Theory and Evidence

Published online by Cambridge University Press:  06 April 2009

Chang-Soo Kim ,
David C. Mauer  and
Ann E. Sherman
Chang-Soo Kim
Affiliation:
Yonsei University, Wonju-City, South Korea
David C. Mauer
Affiliation:
Southern Methodist University, Cox School of Business, 6212 Bishop Boulevard, P.O. Box 750333, Dallas, TX 75275–0333
Ann E. Sherman
Affiliation:
Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong.
Get access Rights & Permissions [Opens in a new window]

Abstract

We model the firm's decision to invest in liquid assets when external financing is costly. The optimal amount of liquidity is determined by a tradeoff between the low return earned on liquid assets and the benefit of minimizing the need for costly external financing. The model predicts that the optimal investment in liquidity is increasing in the cost of external financing, the variance of future cash flows, and the return on future investment opportunities, while it is decreasing in the return differential between the firm's physical assets and liquid assets. Empirical tests on a large panel of U.S. industrial firms support the model's predictions.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 33 , Issue 3 , September 1998 , pp. 335 - 359
Copyright
Copyright © School of Business Administration, University of Washington 1998

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Altman, E. I. “Financial Ratios, Discriminant Analysis, and the Prediction of Corporate Bankruptcy.” Journal of Finance, 23 (1968), 589–609.CrossRefGoogle Scholar
Altman, E. I.Corporate Financial Distress. New York, NY: John Wiley & Sons (1993).Google Scholar
Ang, J. “The Corporate-Slack Controversy.” Advances in Working Capital Management, 2 (1991), 3–14.Google Scholar
Barclay, M. J., and Smith, C. W. Jr. “On Financial Architecture: Leverage, Maturity, and Priority.” Journal of Applied Corporate Finance, 8 (Winter 1996), 4–17.CrossRefGoogle Scholar
Baskin, J. “Corporate Liquidity in Games of Monopoly Power.” Review of Economics and Statistics, 64 (1987), 312–319.CrossRefGoogle Scholar
Begley, J.; Ming, J.; and Watts, S.. “Bankruptcy Classification Errors in the 1980s: An Empirical Analysis of Altman's and Ohlson's Models.” Review of Accounting Studies, 1 (1996), 267–284.CrossRefGoogle Scholar
Brealey, A., and Myers, S.. Principles of Corporate Finance, Fifth Edition. New York, NY: McGraw-Hill Book Co. (1996).Google Scholar
Business Week. “A Bittersweet Year for Corporate America.” (03 27, 1995), 90–95.Google Scholar
Choe, H.; Masulis, R. W.; and Nanda, V.. “Common Stock Offerings across the Business Cycle.” Journal of Empirical Finance, 1 (06 1993), 3–31.CrossRefGoogle Scholar
Damodaran, A.Corporate Finance: Theory and Practice. New York, NY: John Wiley & Sons (1997).Google Scholar
Fazzari, S. M., and Petersen, B. C.. “Working Capital and Fixed Investment: New Evidence on Financing Constraints.” Rand Journal of Economics, 23 (Autumn 1993), 328–342.CrossRefGoogle Scholar
Gertler, M., and Hubbard, R. G.. “Financial Factors in Business Fluctuations.” In Financial Market Volatility—Causes, Consequences, and Policy Responses. Kansas City, MO: Federal Reserve Bank of Kansas City (1988).Google Scholar
Huberman, G. “External Financing and Liquidity.” Journal of Finance, 39 (07 1984), 895–908.CrossRefGoogle Scholar
Ibbotson Associates. Stocks, Bonds, Bills, and Inflation 1995 Yearbook. Chicago, IL: Ibbotson Associates, Inc. (1995).Google Scholar
Jensen, M. C. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, 76 (05 1986), 323–329.Google Scholar
John, T. A. “Accounting Measures of Corporate Liquidity, Leverage, and Costs of Financial Distress.” Financial Management (Autumn 1993), 91–100.CrossRefGoogle Scholar
Kester, C. W. “Capital and Ownership Structure: A Comparison of United States and Japanese Manufacturing Corporations.” Financial Management, 15 (Spring 1986), 5–16.CrossRefGoogle Scholar
MacKie-Mason, J. K. “Do Taxes Affect Corporate Financing Decisions?” Journal of Finance, 45 (12 1990), 1471–1493.CrossRefGoogle Scholar
Martin, J. D., and Morgan, G. E.. “Financial Planning where the Firm's Demand for Funds is Nonstationary and Stochastic” Management Science, 34 (09 1988), 1054–1066.CrossRefGoogle Scholar
Masulis, R. W., and Trueman, B.. “Corporate Investment and Dividend Decisions under Differential Personal Taxation” Journal of Financial and Quantitative Analysis, 23 (12 1988), 369–385.CrossRefGoogle Scholar
Miller, M. H. “Behavioral Rationality in Finance: The Case of Dividends.” Journal of Business, 59 (10 1986), S451–S468.CrossRefGoogle Scholar
Myers, S. C. “Determinants of Corporate Borrowing” Journal of Financial Economics, 5 (11 1977), 147–175.CrossRefGoogle Scholar
Myers, S. C., and Majluf, N. S.. “Corporate Financing and Investment Decisions when Firms Have Information that Investors Do Not Have.” Journal of Financial Economics, 13 (06 1984), 187–221.CrossRefGoogle Scholar
Myers, S. C., and Rajan, R. G.. “The Paradox of Liquidity.” Working Paper, Univ. of Chicago (04 1995).CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Shleifer, A., and Vishny, R.. “Liquidation Values and Debt Capacity: A Market Equilibrium Approach” Journal of Finance, 47 (09 1992), 1343–1366.CrossRefGoogle Scholar
Smith, C. W. “Investment Banking and the Capital Acquisition Process.” Journal of Financial Economics, 15 (01/02 1986), 3–29.CrossRefGoogle Scholar
Smith, C. W., and Watts, R. L.. “The Investment Opportunity Set and Corporate Financing, Dividend, and Compensation Policies” Journal of Financial Economics, 32 (12 1992), 263–292.CrossRefGoogle Scholar
Stohs, M. H., and Mauer, D. C.. “The Determinants of Corporate Debt Maturity Structure.” Journal of Business, 69 (07 1996), 279–312.CrossRefGoogle Scholar
White, H. “A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity.” Econometrica, 48 (05 1980), 817–838.CrossRefGoogle Scholar
Whited, T. M. “Debt, Liquidity Constraints, and Corporate Investment: Evidence from Panel Data” Journal of Finance, 47 (09 1992), 1425–1460.CrossRefGoogle Scholar