Corporate Policies with Temporary and Permanent Shocks

We develop a dynamic model of investment, cash holdings, financing, and risk management policies in which firms face financing frictions and are subject to permanent and temporary cash ow shocks. In this model, target cash holdings depend on the long-term prospects of the firm, implying that the payout policy of the firm, its financing policy, and its cashow sensitivity of cash display a more realistic behavior than in prior models with financing frictions. In addition, risk management policies are richer and depend on the nature of cash ow shocks and potential collateral constraints. Lastly, the timing of investment and the firms initial asset mix both reect financing frictions and the joint effects of permanent and temporary shocks.