Cash-Flow Sensitivities and the Allocation of Internal Cash Flow

Abstract

We study how firms allocate cash flow by estimating the cash-flow sensitivities of various uses of cash flow. We decompose cash flow into a transitory and a permanent component and focus on the allocation of the transitory component, which by construction contains little information about future growth opportunities. We find that more financially constrained firms allocate more transitory cash flow to cash savings and direct less toward investment than do less constrained firms, consistent with constrained firms accumulating liquidity to buffer against future financial constraints. We also illustrate several methodological advantages of our approach over alternative methods in previous studies. (JEL G31, G32)

Do corporate policies follow a life-cycle?

“…,Huang andRitter (2009), andChang, Dasgupta, Wong, andYao (2014), financial (SIC 6000-6999) and utility (SIC 4900-4949) industries are excluded from the sample because the former have relatively low physical capital investment, while the latter are under government regulation. Consistent with, a firm is included in…”

Size of Financing Need and the Choice between Asset Sales and Security Issuances

“…The work of Chang et al. () guides our empirical efforts. They analyze how a firm uses its cash flow in a given year.…”

“…Following Chang et al. (), we exclude firm‐year observations for which the absolute value of the difference between the right‐hand and left‐hand side variables in Equation is more than 1% of beginning‐year total assets. This results in a sample of 76,968 firm‐year observations involving 7,134 firms…”

“…Tangibility is a measure of asset redeployment. It is the ratio of net property, plant, and equipment to total assets (Chang et al., ). SalesGth is the percentage change in sales over previous‐year sales.…”

“…In Chang et al.’s () cash‐flow identity, a firm's investments are net of asset sale proceeds. We keep asset sales separate from investments because we consider an asset sale as a potential source of financing.…”