Corporate debt and cash decisions: A nonlinear panel data analysis

Abstract

This paper investigates firms’ decisions regarding their debt and cash holdings based on their access costs when the interest rate changes. We find that for most of the firms the two items keep changing in the same direction. By the panel smooth transition regression (PSTR) model and impact response analysis, we observe that firms may adjust their financing decisions between the two when the interest rate drops significantly and suddenly, or when the real interest rate becomes negative. In particular, we observe that during the 2008 financial crisis, the lower interest rates caused firms to maintain higher levels of cash and only adjusted their debt temporarily. However, when interest rates were close to zero after the crisis, firms instead increased their debt to deal with the economic uncertainties. Finally, the financially distressed firms make very different financing decisions with the healthy firms when the interest rate changes.