Precautionary Saving in a Financially-Constrained Firm
For a firm that cannot raise external funds, cash on hand serves as precautionary saving. We derive a closed-form expression for the target level of cash on hand in the presence of persistent cash flows. Contrary to conventional wisdom, a mean-preserving increase in the volatility of cash flow can decrease this target. Over the set of admissible parameter values the average impact of volatility on the target is zero. Endogenous selection, reflecting termination of firms that run out of cash, leads to a positive average impact of volatility on the target level of cash, consistent with empirical findings.
We are grateful to Neng Wang for helpful discussions and to seminar and
conference participants at London Business School, Michigan Ross, NBER
Summer Institute 2018, Penn Macro Lunch, Swiss Finance Institute-EPFL, UCLA. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.