Models with a premium on external finance produce counterfactual predictions about liquidity management. This paper addresses this shortcoming by introducing a fixed cost of increasing external finance into an otherwise standard investment/financing problem. This additional financial friction is well motivated by case studies and the analysis shows that it generates more realistic predictions about liquidity management: firms hold external finance and idle cash simultaneously, and may invest an additional dollar of cash flow in liquidity rather than repaying external funds or investing in productive capital.
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