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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.
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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

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