Theses Doctoral

Corporate Investment and Cash Savings under Uncertainty

Chen, Guojun

This dissertation focuses the corporate behaviors in a dynamic world with uncertainty. Especially, I am interested in how firms tradeoff their investment and cash savings when external financing is costly. The first two chapters fit into this theme. One considers optimal investment and financing policies when uncertainty itself is time-varying, the second investigates how firms prepare themselves against devaluation risks. Both chapters build dynamic corporate theories and test them empirically. The third chapter steps back by asking why aggregate volatility is time-varying and why is it persistent in a dynamic general equilibrium with endogenous growth. I show that endogenous asset allocation between different assets can be the reason.
In the first chapter I study how firms manage their cash savings, financing, and investment when aggregate uncertainty is time-varying. I develop and estimate a dynamic model featuring aggregate uncertainty shocks, costly external financing, investment irreversibility, and time-varying risk premia. In my model, firms have a precautionary-savings motive and real options to wait, both of which interact with time-varying uncertainty and are reinforced by state-dependent risk premia. My model confirms previous findings that firms save more in cash and invest less when aggregate uncertainty is high. In addition, I show that in the high uncertainty states, (1) firms with high profitability and low cash are more likely to delay equity issuance, (2) firms with low profitability and high cash are more likely to delay payout, and (3) aggregate equity issuance and payout are both lower. Finally, counterfactual experiments show that (1) a model without dynamic uncertainties cannot explain the observed firm behaviors in high uncertainty states, and (2) time-varying risk premia amplify the impact of the aggregate uncertainty shocks.
In the second chapter, I investigate the relationship between investment and cash savings in a special setting: devaluation episodes in emerging markets. Devaluation events are typically anticipated by the economy but affect local firms in the tradable versus nontradable sectors differently. Tradable firms expect higher cash flows but nontradable firms expect lower ones, even their current cash flows are stable because of the currency-pegging. I build a model to show that, investment and cash savings are both complementarity, because of future prospects, and substitution because of limited current cash balance. Before devaluation, tradable firms invest more due to better expectation of the future but have to substitute for a lower cash savings tomorrow. Empirically, I use difference-in-difference approach and two devaluation episodes in Mexico and Argentina to test these predictions. I find strong evidence in Mexico that tradable firms invested more than nontradable firms and save less, as the devaluation was approaching. Evidence in Argentina is not strong. We discuss the potential remedies and future works to do.
The final chapter explores asset allocation decisions and endogenous growth volatilities in an economy with endogenous growth. Firms have two produced inputs, capital and technology. When a representative firm optimally allocates the investment between the two inputs, both the consumption growth and its volatility are functions of the economy's technology-to-capital ratio. As a result, not only the long run consumption growth is volatile, but also its volatility is endogenously stochastic. Moreover, after a large negative or positive shock, the economy is away from its optimal allocation. This takes time for the economy to travel back to the optimal allocation because of the convex adjustment costs. As a result, both the consumption growth and its stochastic volatility are persistent. Finally, we discuss the asset pricing implication of the model and show that it microfounds Bansal and Yaron (2004) long-run risk model with time-varying volatilities.


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More About This Work

Academic Units
Thesis Advisors
Wang, Neng
Ph.D., Columbia University
Published Here
May 6, 2016