We consider a dynamic model of investment in which a firm can hold inventory to mitigate the price risk of an input commodity. Our model predicts that inventory hedges against net worth risk by smoothing investment in capital, regardless of the level of current net worth. Savings enhance the operational hedge offered by inventory, because they better conserve net worth when the commodity price is low. These predictions are confirmed in a sample of U.S. manufacturing corporations. We find that the empirical sensitivity of inventory investment to price changes is positive for any level of firms’ net worth. Savings and inventory are both positively related to financing constraints and cash-flow risk, but investment is more sensitive to inventory. Received November 13, 2017, Editorial decision September 25, 2018 by Editor Uday Rajan.

We develop a model that endogenizes dynamic financing, investment, and cash retention/payout policies in order to analyze the effect of financial flexibility on firm value. We show that the value of financing flexibility depends on the costs of external financing, the level of corporate and personal tax rates that determine the effective cost of holding cash, the firm's growth potential and maturity, and the reversibility of capital. Through simulations, we demonstrate that firms facing financing frictions should simultaneously borrow and lend, and we examine the nature of dynamic debt and liquidity policies and the value associated with corporate liquidity.

This paper studies the quantitative impact of microprudential bank regulations on bank lending and value metrics of efficiency and welfare in a dynamic model of banks that are financed by debt and equity, undertake maturity transformation, are exposed to credit and liquidity risks, and face financing frictions. We show that (1) there exists an inverted U-shaped relationship between bank lending, welfare, and capital requirements, (2) liquidity requirements unambiguously reduce lending, efficiency, and welfare, and (3) resolution policies contingent on observed capital, such as prompt corrective action, dominate in efficiency and welfare terms (noncontingent) capital and liquidity requirements.