The Corporate Propensity to Save




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    • Riddick is from the American University. Whited is from the University of Rochester. We are grateful for helpful comments and suggestions from an anonymous referee, an associate editor, and the editors (Cam Harvey and John Graham) as well as Viral Acharya; Morris Davis; Mark Garmaise; Robert Hauswald; Chris Hennessy; Holger Mueller; Emi Nakamura; Michael Roberts; Josef Zechner; and seminar participants at the American University, Boston College, Columbia, Cornell, Duke, Université de Lausanne, École des Hautes Études Commerciales de Paris, London Business School, the London School of Economics, Northwestern, the Norwegian School of Management, Rice, Rochester, the University of Vienna, the University of Wisconsin, and Yale. Bobby Hart of Thompson Financial was helpful in data acquisition, and Alex Boquist and Michael R. Sullivan provided research assistance. Leigh Riddick also wishes to acknowledge research support from the Kogod School of Business and American University.


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.