1 Almeida is at New York University. Campello and Weisbach are at the University of Illinois. We thank an anonymous referee, Rick Green (the editor), Viral Acharya, Dan Bernhardt, Matt Billett, Long Chen, Ted Fee, Jon Garfinkel, John Graham, Charlie Hadlock, Jarrad Harford, Harrison Hong, George Penna · 2 Almeida is at New York University. Campello and Weisbach are at the University of Illinois. We thank an anonymous referee, Rick Green (the editor), Viral Acharya, Dan Bernhardt, Matt Billett, Long Chen, Ted Fee, Jon Garfinkel, John Graham, Charlie Hadlock, Jarrad Harford, Harrison Hong, George Penna
Abstract
We model a firm's demand for liquidity to develop a new test of the effect of financial constraints on corporate policies. The effect of financial constraints is captured by the firm's propensity to save cash out of cash flows (the cash flow sensitivity of cash ). We hypothesize that constrained firms should have a positive cash flow sensitivity of cash, while unconstrained firms' cash savings should not be systematically related to cash flows. We empirically estimate the cash flow sensitivity of cash using a large sample of manufacturing firms over the 1971 to 2000 period and find robust support for our theory.