The Sensitivity of Cash Savings to the Cost of Capital
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.
We thank Heitor Almeida for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.