The first essay tests alternative theories about the effect of asset liquidity on capital structure and debt capacity. Using data from a broad sample of U.S. public companies, I find that leverage is positively related to asset liquidity. The relation is stronger following negative shocks to asset liquidity and is more significant at high levels of leverage. In addition, I find some evidence that the positive relation between asset liquidity and debt requires constraints on the disposition of liquid assets. The results are consistent with the view that the costs of financial distress and inefficient liquidation are economically important and that managers trade off the costs and benefits of debt when making capital structure decisions. The second essay investigates the effect of cash holdings on value, investment, and sales growth for financially constrained and unconstrained firms. Existing studies find that financially constrained firms accumulate higher cash holdings and retain a greater proportion of cash flow. However, there is limited evidence on whether cash is more valuable for constrained firms. I find that cash holdings are significantly more valuable for constrained firms than for unconstrained firms. Further analysis suggests that cash has higher value for constrained firms in part because, on the margin, cash allows constrained firms to increase investment into projects that are more valuable than those of unconstrained firms. The evidence is consistent with the hypothesis that greater cash holdings of constrained firms are a value-increasing response to costly external financing.
