Essays on asset liquidity, cash holdings, and the cost of corporate debt

Abstract

This dissertation examines the relationship between the ability of a firm to sell its real assets (asset liquidity) and its cash holdings behavior as well as its cost of debt. In essay 1, I show that for financially constrained firms there exists a negative relationship between the liquidity of a firm's real assets and the size of its cash holdings, however no such relationship is present for financially unconstrained firms. This indicates a substitution effect between cash balances and liquid real assets when access to external capital markets is limited. Additionally, I find that among financial constrained firms the market value of cash holdings is lower among firms possessing more liquid real assets. In essay 2, I examine the implications of this cash holdings/asset liquidity relationship on the cost of corporate debt. First, I develop a simple two period model of credit spreads endogenizing the cash holdings/asset liquidity trade-off and show that there exists a non-linear (U-shaped) relationship between credit spreads and asset liquidity. Empirically, I show that indeed there is a non-linear relationship between credit spreads and asset liquidity such that credit spreads are decreasing with liquidity for low liquidity firms and increasing for high liquidity firms. In addition, cash holdings plays a mitigating role in the observed effect of asset liquidity on credit spreads.