FRIC/Finance Seminar with Konstantin W. Milbradt, Northwestern University

The Department of Finance and FRIC, Center for Financial Frictions, are proud to announce the upcoming seminar with Konstantin W. Milbradt, Kellogg School of Management, Northwestern University.

Konstantin W. Milbradt will present:

Corporate Liquidity Management under Moral Hazard

ABSTRACT
We present a model of liquidity management and financing decisions under moral hazard in which a firm accumulates cash to forestall liquidity default. When the cash balance is high, a tension arises between accumulating more cash to reduce the probability of default and providing incentives for the manager. When the cash balance is low, the firm hedges against liquidity default by transferring cash flow risk to the manager via high powered incentives. Under mild moral hazard, firms with more volatile cash flows tend to transfer less risk to the manager and hold more cash. In contrast, under severe moral hazard, an increase in cash-flow volatility exacerbates agency cost, thereby reducing firm value, overall hedging and in particular precautionary cash-holdings. Agency conflicts lead to endogenous, state-dependent refinancing costs related to the severity of the moral hazard problem. Financially constrained firms pay low wages and instead promise the manager large rewards in case of successful refinancing.