Corporate Policies and the Term Structure of Risk

We build a dynamic corporate finance model with heterogeneity in the pricing and in the firm’s exposure to aggregate risks of various persistence. All else equal, we show that if long-term (persistent) shocks have a higher market price than short term (temporary) shocks, firms shorten the horizon of corporate policies, favoring payouts over investment. In the cross section, this effect is stronger for firms more exposed to long-term shocks, but can be reversed for firms more exposed to short term shocks. Our analysis is extended to embed time variation in risk prices over the business cycle, motivated by recent evidence on the term structure of equity.