Recent observations of monetary policies have revived the issue of how monetary policies would affect firms’ investment, especially their differential effects across different industries and firms. Empirical evidence on how financial heterogeneity across firms affect the transmission of monetary and other macroeconomic shocks is, at best, scant. With financial heterogeneity across firms, which firms are the most responsive to changes in monetary policy and why?
The purpose of the study is to provide evidence on the role of financial frictions in the monetary transmission mechanism and assess the differences in firms’ responses to monetary policy shocks conditional on their financial characteristics. Further, this study assesses that the financial conditions of non financial firms help to explain their investment activity employing local projections in the spirit of Jorda (2005) and using the high-frequency event-study approach with quarterly Compustat data.
Two very recent studies, Jeenas (2018) examine the heterogeneous responses of investment to high frequency identified monetary policy shock across groups of low leverage and high leverage firms and James Cloyne et. al (2018) show that age and paying no dividends are stronger predictors of a larger investment response and they find that balance sheet position of firms evolves over time in response to changes in monetary policy. However, this study will focus two financial indicators to measure financial heterogeneity which are leverage and cash holdings.
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The first choice of leverage as a financial frictions measure (Leland,1994 and Hennessy and Whited ,2007) imply that firms with higher leverage would have higher probability of default and face a higher cost of debt. The next measure is the lagged cash holdings of the firm. A firm with higher cash holdings require less external financing to invest in investment or face a lower likelihood of default. Cash holding firms can be distinct from their borrowing because of the different hedging and liquidity properties of cash and debt. In addition, cash management has implications for firms’ investment behavior and can explain heterogeneous investment behavior in response to aggregate shocks.
This study contributes to the literature that studies how the effect of monetary policy varies across firms. Some papers, including Kashyap, Lamont and Stein (1994), Gertler Gilchrist (1994) find that smaller and presumably more credit constrained firms are more responsive to monetary policy. This study contributes to this literature by showing how different level of leverage and cash holding firm are varies with their response to monetary policy.
This study closes to the current paper Ottonello and Winberry (2018) who study Compustat firms’ responses to high- frequency identified monetary shocks conditional on leverage and credit ratings as proxies for default risk. In their model, low-risk firms are more responsive to monetary shocks because their marginal cost of finance is relatively flat. However, in the transmission of interest rate fluctuations to investment debt may not be marginal source of financing, in that case firm’s liquid funds like cash on hand play a key role. By emphasizing the relevance of cash holding position and introducing extensive margin decision, this study make contributions for firms’ responsiveness to shocks.
