The Sensitivity of Cash Savings to the Cost of Capital

We theoretically and empirically show that in the presence of a time-varying cost of capital (COC), firms save from external capital when the firm-specific COC is low to hedge against the risk of underinvestment due to a higher COC in the future. This hedging motive drives the sensitivity of cash saving to the COC in both financially constrained and currently unconstrained firms. This sensitivity is especially pronounced among firms that tend to face a higher COC when in need of external finance. These firms with high hedging motives issue excess capital to save cash when the COC is lower. Such cash saving behavior is influenced by future investments.