Debt Issue Motives and Earnings Optimism

The precautionary motive for finance predicts that firms make large issues to build financial liquidity when capital market conditions are favorable, and issue less or not at all when conditions are unfavorable. The liquidity squeeze framework predicts that firms issue to fund liquidity squeezes, regardless of market conditions. We find that both frameworks help explain the timing of issuance decisions, but only the precautionary framework explains issue size. With respect to timing, the majority of firms facing ex-ante liquidity squeezes do not issue. Squeezed firms issue if capital market conditions are favorable, but cut spending otherwise. With respect to size, large issues are not associated with large liquidity squeezes. Instead, firms raise more capital when issuance conditions are favorable, and use the majority of the proceeds to build financial liquidity, both by increasing cash and by refinancing debt to extend maturity.