Dpto. Economía y Empresa

This paper explores the external financing–cash flow relationship in capital structure theory by comparing unlisted (financially constrained) and listed (financially unconstrained) companies. We postulate that investment is determined endogenously in the case of unlisted firms, as they are strongly dependent on internally generated funds (cash flow). Consequently, unlisted firms invest their cash flow in profitable projects, using any residual cash flow to increase their holdings of safe assets. In turn, listed companies determine their investment exogenously and may reduce leverage if they raise an excess of cash flow. As a result, listed companies would react more negatively to shocks in cash flow. Our findings reveal that both unlisted and listed companies show a negative external financing–cash flow relationship, that of the latter being clearly more intense.

We analyze the relevance of adjustment costs in keeping Spanish public firms away from their target leverage. We argue that firm's cash flow outcomes determine the importance of the adjustment costs on capital structure changes. Then, we estimate capital structure adjustment speeds across three different cash flow realizations. We report that during years in which either over-levered or under-levered Spanish public firms make changes in their financing decisions, as a result of their high cash flow realizations, they close significantly more of the gap between current and target capital structure than those firms with intermediate and low cash flow observations. Moreover, independently of the cash flow level, we find that leverage adjusts more quickly for over-levered than for under-levered firms.

This article explores the cash–cash flow relationship by comparing financially constrained and financially unconstrained companies. Unlike previous research, we test the sensitivity of cash to cash flow by considering unlisted firms as constrained and listed firms as unconstrained. Our empirical evidence is based on findings from Spanish firms and is consistent with the core rationale that unlisted firms face more difficulties than their listed counterparts when looking for funding from external markets. As a result, unlisted firms tend to hoard significant amounts of cash out of the generated cash flow, while listed firms do not. Our findings are robust to a number of additional empirical tests.

The relevance of risk aversion as the key factor explaining the fluctuations of the economy is receiving increasing attention since the Great Recession. The role of financial shocks in the economic fluctuations and their associated amplifying effects are crucial aspects in the monetary policies followed by central banks around the world. The underlying mechanism behind these effects is directly linked to the time-varying behavior of risk aversion, especially during recessions. The reason is that risk aversion is strongly related to the behavior of the expected market risk premium, which is a fundamental input in the cost of capital and investment decisions of firms through the business cycle. In this research, we present an analysis of the interplay between the expected market risk premium, time-varying risk aversion, and economic uncertainty for the Spanish economy. We estimate risk aversion from aggregate consumption of Spanish households, while the expected market risk premium is extracted from options traded on the IBEX-35 index. Note that we put together variables from the real economy and financial markets. We show that both variables are positive and significantly related, clarifying the important connection between the real and financial sectors of the Spanish economy. More precisely, we show that both risk aversion and the expected market risk premia at alternative horizons are counter-cyclical, and that the slope of the term structure of the expected market risk premium is steeply downward sloping during recessions. Moreover, we find that risk aversion significantly amplifies the effects of adverse economic uncertainty shocks on the expected market risk premium. Therefore, it should not be surprising the collapse of financial prices when there is shock in uncertainty amplified by the increase in risk aversion. The corresponding rise in the expected market risk premium explains the drop in equity prices during bad economic times. The persistence of these effects depends on the nature of the economic crisis. In this framework, we understand both the initial dramatic drop in asset prices provoked by the exogenous COVID-19 crises, and the subsequent recuperation. To conclude, the positive association between uncertainty shocks, risk aversion and the expected market risk premium has extremely important consequences for the investment and output growth fluctuations of the Spanish economy.