Posts Tagged ‘Liquidity’

Cash Holdings and Credit Risk  (via Social Science Electronic Publishing, Inc.)
Authors: Viral V. Acharya, New York University – Leonard N. Stern School of Business; Sergei A. Davydenko, University of Toronto – Finance Area; Ilya A. Strebulaev, Stanford University – Graduate School of Business; National Bureau of Economic Research
Date: August 1, 2012
Rock Center for Corporate Governance at Stanford University Working Paper No. 123

SSRN Abstract:  Intuition suggests that firms with higher cash holdings should be ‘safer’ and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes riskier firms to accumulate higher cash reserves. In contrast, spreads are negatively related to the part of cash holdings that is not determined by credit risk factors. Similarly, although firms with higher cash reserves are less likely to default in the short term, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk.