The Sensitivity of Cash Saving to the Cost of Capital

Zhaoxia Xu, Viral V. Acharya, and Soku Byoun

♦ We show that with a time-varying cost of capital (COC), firms save from external capital when the firm-specific COC is low to hedge against future underinvestment risks associated with a higher COC. This hedging motive drives the sensitivity of cash saving to the COC in both financially constrained and currently unconstrained firms. This sensitivity is especially pronounced among firms that face a higher COC when in need of external finance. Firms with high hedging motives issue excess capital to save cash when the COC is lower and use cash savings for future investment.

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