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Ronald W. Anderson, Andrew Carverhill, Corporate Liquidity and Capital Structure, The Review of Financial Studies, Volume 25, Issue 3, March 2012, Pages 797–837, https://doi.org/10.1093/rfs/hhr103
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Abstract
We solve for a firm's optimal cash holding policy within a continuous time, contingent claims framework using dividends, short-term borrowing, and equity issues as controls assuming mean reversion of earnings. Optimal cash is non-monotone in business conditions and increasing in the level of long-term debt. The model matches closely a wide range of empirical benchmarks and predicts cash and leverage dynamics in line with the empirical literature. Firm value is quite insensitive to changes in the level of long-term debt. The model has interesting implications for asset substitution, hedging, and pecking order. Growth opportunities do not greatly affect cash holding policy.