The Corporate Propensity to Save

TLDR

Corporations accumulate liquid assets to manage uncertainty and financing needs, prompting questions about the drivers of their savings behavior. The study theoretically shows that intertemporal trade‑offs between interest‑income taxation and external‑finance costs determine optimal corporate savings. The authors model these trade‑offs to derive optimal savings decisions. Empirically, firms exhibit negative propensities to save out of cash flow, with income uncertainty driving savings more than external‑finance constraints, and the negative relationship between cash flow and reserves contradicts prior evidence that saving propensities can measure external‑finance constraints.

Abstract

ABSTRACT Why do corporations accumulate liquid assets? We show theoretically that intertemporal trade‐offs between interest income taxation and the cost of external finance determine optimal savings. Intriguingly, we find that, controlling for Tobin's q , saving and cash flow are negatively related because firms lower cash reserves to invest after receiving positive cash‐flow shocks, and vice versa. Consistent with theory, we estimate negative propensities to save out of cash flow. We also find that income uncertainty affects saving more than do external finance constraints. Therefore, contrary to previous evidence, saving propensities reflect too many forces to be used to measure external finance constraints.