Finance Seminar（2015-01）

Topic: On the Interest Sensitivity of Corporate Cash: Theory and Evidence

Speaker: Na Zhang, Fudan University

Time: Wednesday, 4 March, 10:00-11:30

Location: Room 217, Guanghua Building 2

Abstract: In this paper, we examine the interest sensitivity of corporate cash holdings. We start by presenting an empirical fact on the lack of a significantly negative relationship between nominal interest rate and firms' cash holdings, which is in contrast to conventional wisdom. This finding is robust to various measures of nominal interest rates and various regression specifications. We then develop a structural model to study the role of nominal interest rates in shaping firms' cash policy. In the model, firms face productivity uncertainty and financial frictions, and need to pay wage bills up front. They have access to external borrowings: (i) risk-free intra-period bank loans, yet subject to a borrowing constraint, and (ii) risky inter-period debt whose value is endogenously determined by market conditions as well as prevailing nominal interest rates. Due to the borrowing constraint and the high costs associated with debt financing, firms have an incentive to accumulate cash. We show that corporate cash holdings are highly responsive to credit spread, the difference between the endogenous borrowing rate on debt and nominal interest rate. This result is supported by data and provides a potential explanation for the insignificance of the interest-cash relation highlighted in the empirical section. The calibrated model is also able to replicate a number of other empirical features. Using the validated model, we lastly estimate the non-linear effect of nominal interest rates on firms' cash policy.