Corporate Policies under Transitory and Permanent Shocks of Cash Flows: An Empirical Study of Cash Management

Document Type : Research Paper


1 Assistant Prof., Department of Financial Management and Insurance, Faculty of Management, University of Tehran, Tehran, Iran.

2 MSc. Student, Department of Finance, Faculty of Management, University of Tehran, Tehran, Iran.


Objective: Theoretical corporate finance literature claims that financial policies of firms are related to the nature of their cash flows shocks; that is firms respond to transitory and permanent cash flow shocks differently. However, a limited number of surveys are conducted in the empirical corporate finance literature to verify the validation of these models.  The main objective of this article is to fill this gap.
Methods: First of all, the existence of a permanent element in the cash flows of firms will be tested. Secondly, an adjusted filter will be devised to identify short term and permanent shocks to firms' cash flows and estimate their characteristics. This filter is adjusted according to the dynamics of this article's theoretical model. Eventually, the basic axioms of the dynamic framework on which the theoretical model is based, will be analyzed and then the hypotheses will be tested among sample classes.
Results: 1- Modeling operational cash flows of companies as a combination of permanent and short-term stochastic processes can eliminate most of the problems assuming a permanent random process governing cash flows. 2- Pieces of evidence show that in firms that are operationally the same, the characteristics of permanent cash flows shock resemble. 3- While it is common to classifying stocks of companies whose sales are not affected by economic cycles as defensive industries, it seems that the separation of short-term and permanent shocks can provide a better criterion or distinguishing tool to interpreting this concept. 4- Firms that are exposed to higher cash flows volatility or experienced a greater permanent growth rate, hold a higher level of cash flows and at any time that they do external financing via equities, issue more stocks.
Conclusion: According to the findings, separating short term and permanent shocks presents a strong intuition to describe firms' financial policies, and most implementations of the theoretical model of this article are acceptable.


Amir Teimoori, R. & Jalaee, A. & Zayandeh Roodi, M. (2017). Investigating the Impact of Iran-Germany Business Cycle Synchronization on the Friction and Depth of Financial Markets in Iran (Markov Switching Bayesian VAR Method). Financial Research Journal, 19(3), 341-364. (in Persian)
Bhamra, H. S., Kuehn, L.-A., & Strebulaev, I. A. (2010). The levered equity risk premium and credit spreads: A unified framework. The Review of Financial Studies, 23(2), 645-703.
Bolton, P., Chen, H., & Wang, N. (2011). A unified theory of Tobin's q, corporate investment, financing, and risk management. The journal of Finance, 66(5), 1545-1578.
Brennan, M. J., & Schwartz, E. S. (1985). Evaluating natural resource investments. Journal of business, 135-157.
Byun, S. K., Polkovnichenko, V., & Rebello, M. J. (2018). Composition of cash flow shocks and debt financing. Available at SSRN 3222960.
Chang, X., Dasgupta, S., Wong, G., & Yao, J. (2014). Cash-flow sensitivities and the allocation of internal cash flow. The Review of Financial Studies, 27(12), 3628-3657.
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: A real options approach. Journal of Financial and Quantitative Analysis, 305-334.
Decamps, J.-P., Gryglewicz, S., Morellec, E., & Villeneuve, S. (2016). Corporate policies with permanent and transitory shocks. The Review of Financial Studies, hhw078.
DeMarzo, P. M., & Sannikov, Y. (2006). Optimal security design and dynamic capital structure in a continuous-time agency model. The journal of Finance, 61(6), 2681-2724.
DeMarzo, P. M., Fishman, M. J., He, Z., & Wang, N. (2012). Dynamic agency and the q theory of investment. The journal of Finance, 67(6), 2295-2340.
 Goldstein, R., Ju, N., & Leland, H. (2001). An EBIT‐based model of dynamic capital structure. The Journal of Business, 74(4), 483-512.
Gorbenko, A. S., & Strebulaev, I. A. (2010). Temporary versus permanent shocks: Explaining corporate financial policies. The Review of Financial Studies, 23(7), 2591-2647.
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of financial economics, 60(2-3), 187-243.
Gryglewicz, S., Mancini, L., Morellec, E., Schroth, E. J., & Valta, P. (2020). Corporate Policies with Permanent and Transitory Shocks: An Empirical Investigation. Swiss Finance Institute Research Paper (18-21).
Gryglewicz, S., Mayer, S., & Morellec, E. (2019). Agency conflicts and short-versus long-termism in corporate policies. Journal of financial economics, 136, 718-742.
Guay, W., & Harford, J. (2000). The cash-flow permanence and information content of dividend increases versus repurchases. Journal of financial economics, 57(3), 385-415.
Guiso, L., Pistaferri, L., & Schivardi, F. (2005). Insurance within the firm. Journal of Political Economy, 113(5), 1054-1087.
Hackbarth, D., Miao, J., & Morellec, E. (2006). Capital structure, credit risk, and macroeconomic conditions. Journal of financial economics, 82(3), 519-550.
Hackbarth, D., Rivera, A., & Wong, T.-Y. (2018). Optimal short-termism. European Corporate Governance Institute (ECGI). Finance Working Paper No. 546/2018. Available at SSRN:
Hoffmann, F., & Pfeil, S. (2010). Reward for luck in a dynamic agency model. The Review of Financial Studies, 23(9), 3329-3345.
Lee, B.-S., & Rui, O. M. (2007). Time-series behavior of share repurchases and dividends. Journal of Financial and Quantitative Analysis, 119-142.
Leland, H. E. (1994). Corporate debt value, bond covenants, and optimal capital structure. The journal of Finance, 49(4), 1213-1252.
McDonald, R. L., & Siegel, D. R. (1985). Investment and the valuation of firms when there is an option to shut down. International economic review, 26(2), 331-349.
Mehrabanpour, M. & Alavi Nasab, M. & Abbasian, E. & Porkavosh, T. (2019). The Impact of Financial Inflexibility on Value Anomaly. Financial Research Journal, 21(4), 612-636. (in Persian)
Shariatpanahi, M. & Amiri, M. & Babajani, J. & Taghavi Fard, M. & Khalili, E. (2020). Model Determination for Equilibrium Valuation of Startup Companies Using Real Option Method in the Presence of Agency Cost. Financial Research Journal, 22(2), 180-205.
(in Persian)
Strebulaev, I. A., & Whited, T. M. (2012). Dynamic models and structural estimation in corporate finance. Final pre-publication version, published in Foundations and Trends in Finance, 6, 1-163.
Zamani Sabzi, M. & Saeedi, A. & Hassani, M. (2020). Capital Structure Adjustment Speed and the Effect of Boom and Recession on that: Evidence from Tehran Stock Exchange Listed Companies. Financial Research Journal, 22(2), 160-181. (in Persian)