International evidence on the non-linear impact of leverage on corporate cash holdings

This paper investigates cash holding behaviour of firms from France, Germany, Japan, the UK and the US using data for 4069 companies over the period 1996–2000. Our focus is particularly on the relation between cash holdings and leverage. We argue that the impact of leverage on cash balances of firms is likely to be non-monotonic. To the extent that leverage of firms acts as a proxy for their ability to issue debt one would expect a negative (substitution effect) relation between leverage and cash holdings. However, as leverage increases firms are likely to accumulate larger cash reserves to minimise the risk of financial distress and costly bankruptcy. Thus, one would expect a positive (precautionary effect) relationship between cash holdings and leverage at high levels of leverage. Our findings provide strong and robust support for a significant non-linear relation between cash holdings and leverage. Additionally, our results show that the impact of leverage on cash holdings partly depends on country-specific characteristics such as the degree of creditor protection, shareholder protection, and ownership concentration.     

The impact of competition and time-to-finance on corporate cash holdings

This paper empirically documents how the interaction between competition and time frictions in capital markets impacts firms' cash management decisions. Using the introduction of the U.S. Securities Offering Reform in 2005 as a quasi-natural experiment, we show that a shorter time-to-finance leads to a reduction in corporate cash holdings. This effect is significantly stronger for firms that are exposed to preemption risk. Furthermore, patents mitigate the risk of preemption and the effect of a reduction in time-to-finance on cash holdings is strongest for unconstrained firms.     

Credit refinancing and corporate tax avoidance

This study examines the disciplining effects of credit markets on firms’ corporate tax avoidance strategies. We show that, during adverse credit market conditions, firms with refinancing needs prefer to limit the after-tax cash flow benefits of tax avoidance to regain access to traditionally risk-averse credit markets. Our results show that firms increase their cash effective tax rate by two percentage points when facing refinancing constraints, and this effect is more pronounced for firms with lower asset redeployability and higher default probability. However, corporate governance mechanisms mitigate the relationship between tax avoidance and credit refinancing. Moreover, we show that firms decrease their tax avoidance strategies while leaving their leverage and debt shield unchanged. Overall, our findings are consistent with the observation that credit markets put pressure on tax-avoiding firms and contribute to the policy debate on disciplining tax avoiders.     

Climate risk: The price of drought

We document a significant positive relation between drought risk and the cost of equity capital. Our estimation shows that the cost of equity capital is 92 basis points higher for firms affected by severe drought conditions. We provide evidence that when firms are affected by droughts, firms with higher local institutional holdings exhibit a higher cost of equity capital. This result supports the well-known local bias of institutional investors, and suggests that diversification cannot fully eliminate the loss in wealth caused by droughts. Consistent with theoretical predictions, we find that drought duration and drought intensity further increase a firm's risk premium. However, for firms with diversified cash flows/investments, geographically dispersed business operations, and high cash holdings, the impact of drought on the expected return is significantly lessened. Overall, our findings show that investors require a higher rate of returns on firms affected by droughts and offer implications on how firms can mitigate the impact of droughts on their cost of capital.     

Cash holdings and R&D smoothing

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998–2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.     

The value of excess cash and corporate governance: Evidence from US cross-listings

We examine whether and how a US cross-listing mitigates the risk that insiders will turn their firm’s cash holdings into private benefits. We find strong evidence that the value investors attach to excess cash reserves is substantially larger for foreign firms listed on US exchanges and over-the-counter than for their domestic peers. Further, we show that this excess-cash premium stems not only from the strength of US legal rules and disclosure requirements, but also from the greater informal monitoring pressure that accompanies a US listing. Overall, because investors’ valuation of excess cash mirrors how they expect the cash to be used, our analysis shows that a US listing constrains insiders’ inefficient allocation of corporate cash reserves significantly.     

Shariah compliance and corporate cash holdings

This study investigates the influence of Shariah compliance status on cash holding levels and the speed of adjustment of non-financial listed firms in six Gulf Cooperation countries from 2005 to 2016. The results show that Shariah compliance status has a significant effect on firms’ cash holding decisions. Shariah-compliant firms have significantly higher cash holding levels than non-Shariah-compliant firms. Further, Shariah-compliant firms adjust more quickly towards their target cash holdings than their conventional counterparts. In our view, Shariah-compliant firms are subject to multiple restrictions that limit their external financing channels. Therefore, holding larger cash reserves is important as it helps gain from the transaction cost motive of holding cash. The findings of this study have important implications for regulators, investors and managers. To the best of our knowledge, this study is the first to compare the effect of Shariah compliance on firms’ cash holdings and the speed of adjustment towards the trade-off theory’s optimal cash holding target.     

Excess cash holdings and shareholder value

We examine the determinants of corporate cash holdings in Australia and the impact on shareholder wealth of holding excess cash. Our results show that a trade‐off model best explains the level of a firm’s cash holdings in Australia. We find that ‘transitory’ excess cash firms earn significantly higher risk‐adjusted returns compared to ‘persistent’ excess cash firms, suggesting that the market penalises firms that hoard cash. The marginal value of cash also declines with larger cash balances, and the longer firms hold on to excess cash. The results are consistent with agency costs associated with persistence in excess cash holdings.     

Share pledging,payout policy,and the value of cash holdings

Share pledging for insiders’ personal bank loans is associated with the agency problems of insider risk aversion and stock price crash risk. We examine the relation between insider share pledging and the value of cash holdings using the pledging data of listed firms in Taiwan. We find that the value of cash holdings is lower for pledging firms, especially for those that are relatively more risk averse. Pledging firms that repurchase shares have a higher marginal value of cash than those with other payout methods, likely due to the role of repurchases in reducing the stock price crash risk. Our results show how insiders’ personal financing incentives arising from share pledging would affect the value of cash holdings from the perspective of agency problems and payout policy.     

Green credit policy and corporate cash holdings: Evidence from China

In 2012, China implemented a green credit policy (GCP) that restricts bank credits to heavily polluting firms. Using a difference-in-differences research design, we find that polluting firms increased their cash reserves by 9.5% after the GCP's issuance relative to non-polluting firms. We also document that the GCP significantly reduces firms' access to bank finance but increases the value of cash. Cross-sectional analysis shows that the increase in cash holdings is more significant for firms with greater financial constraints, firms with more investment opportunities, and high-tech companies. Overall, our findings are consistent with a constraint explanation: when external financing is restricted, firms retain more cash to meet future investment needs.     

Corporate precautionary cash holdings

This paper models the precautionary motive for a firm's cash holdings. A two-period investment model shows that the cash holdings of financially constrained firms are sensitive to cash flow volatility because financial constraints create an intertemporal trade-off between current and future investments. When future cash flow risk cannot be fully diversifiable, this intertemporal trade-off gives constrained firms the incentives of precautionary savings: they increase their cash holdings in response to increases in cash flow volatility. However, there is no systematic relationship between cash holdings and cash flow volatility for unconstrained firms. We test the empirical implications of our theory using quarterly information from a sample of U.S. publicly traded companies from 1997 to 2002, and find that the empirical evidence supports our theory.     

CEO inside debt and corporate debt maturity structure

This paper examines the relation between chief executive officer (CEO) inside debt holdings and corporate debt maturity. We provide robust evidence that inside debt has a positive effect on short-maturity debt and that this effect is concentrated in financially unconstrained firms that face lower refinancing risk. Our analysis further shows that CEO inside debt helps reduce the cost of debt financing. Overall, our results indicate that managerial holdings of inside debt facilitate access to external debt financing and reduce refinancing risk, thus incentivizing managers to use less costly shorter term debt.     

Cash holdings in family firms: CEO identity and implications for firm value

We investigate the cash holdings policy of family firms and examine potential value implications. Family firms hold more cash than other firms, with an average difference of 2.3% of total assets. This result is driven by firms managed by heir CEOs. While the cash holdings policy of first‐generation family firms is more sensitive to firm risk, consistent with founders’ increased risk aversion, that of later‐generation firms is more sensitive to information asymmetry and agency conflicts. Heir CEOs’ cash policies destroy value, as the marginal value of an additional Euro suffers from a 38.3‐cent discount, on average, relative to non‐family firms.     

State ownership,soft-budget constraints,and cash holdings: Evidence from China’s privatized firms

We study the relation between state ownership and cash holdings in China’s share-issue privatized firms from 2000 to 2012. We find that the level of cash holdings increases as state ownership declines. For the average firm in our sample, a 10 percentage-point decline in state ownership leads to an increase of about RMB 55 million in cash holdings. This negative relation can be attributable to the soft-budget constraint (SBC) inherent in state ownership. The Chinese financial system is dominated by the state-owned banks, an environment very conducive for the SBC effect. We further examine and quantify the effect of state ownership on the value of cash and find that the marginal value of cash increases as state ownership declines. The next RMB added to cash reserves of the average firm is valued at RMB 0.96 by the market. The marginal value of cash in firms with zero state ownership is RMB 0.36 higher than in firms with majority state ownership. The SBC effect exacerbates agency problems inherent in state-controlled enterprises, contributing to their lower value of cash.     

Corporate cash holdings: Evidence from Switzerland

This paper investigates the determinants of cash holdings for a comprehensive sample of Swiss non-financial firms between 1995 and 2004. The median Swiss firm holds almost twice as much cash and cash equivalents as the median US or UK firm. Our results indicate that asset tangibility and firm size are both negatively related to corporate cash holdings, and that there is a non-linear relationship between the leverage ratio and liquidity. Dividend payments and operating cash flows are positively related to cash reserves, but we cannot detect a significant relationship between growth opportunities and cash holdings. Most of these empirical findings, but not all of them, can be explained by the transaction costs motive and/or the precautionary motive. Analyzing the corporate governance structures of Swiss firms, we document a non-linear relationship between managerial ownership and cash holdings, indicating an incentive alignment effect and an opposing effect related to increasing risk aversion. Finally, our results suggest that firms in which the CEO simultaneously serves as the COB hold significantly more cash.

Do corporate governance mechanisms matter for cash holdings and firm value?

This paper examines the relationships between firm-level corporate governance mechanisms and cash holdings; along with their combined effects on firm value for a sample of firms listed in Singapore and Malaysia. Firms with less effective governance attributes are found to be more inclined to accumulate cash than those with more effective governance. The results support the flexibility hypothesis in that an increase in agency conflicts between managers and minority shareholders leads to entrenched managers having more discretion to hoard cash reserves. In addition, the incremental value of holding excess cash is shown to be negative for firms with a single leadership structure, firms with a pyramidal ownership structure, as well as family-controlled firms. The discounts associated with these firms may reflect investors’ recognition of the possibility of managerial entrenchment.     

The effect of predation risk on cash holdings: Empirical evidence from the U.S. property‐liability insurance industry

Corporate cash holdings play a significant role in the U.S. property‐liability insurance industry yet the topic of insurer cash holdings policy has largely been overlooked by prior empirical research. While a number of studies have investigated firm‐specific factors related to cash holdings in the insurance industry, prior research has not examined how market concentration and potential predation risk impact cash holdings. We propose a new measure of market concentration and provide evidence in support of the predation risk theory. Specifically, we show that insurers exposed to more concentrated markets tend to hold more cash. Furthermore, the relation between market concentration and cash holdings is influenced by access to internal capital. While unaffiliated insurers without access to internal capital hold greater levels of cash in more concentrated markets, group insurers with access to internal capital do not hold greater levels of cash to mitigate predation risk.     

The strategic use of corporate cash holdings in collective bargaining with labor unions

We provide evidence that firms in more unionized industries strategically hold less cash to gain bargaining advantages over labor unions and shelter corporate income from their demands. Specifically, we show that corporate cash holdings are negatively related with unionization. We also find that this relation is stronger for firms that are likely to place a higher value on gaining a bargaining advantage over unions and weaker for those firms in which lower cash holdings provide less credible evidence that a firm is unable to concede to union demands. Additionally, we show that for unionized firms increases in cash holdings raise the probability of a strike. Finally, we show that unionization decreases the market value of a dollar of cash holdings. Overall, our findings indicate that firms trade-off the benefits of corporate cash holdings with the costs resulting from a weaker bargaining position with labor.     

What determines cash holdings at privately held and publicly traded firms? Evidence from 20 emerging markets

We provide one of the first large sample studies to examine how firm-level characteristics and national-level institutions affect cash balances in privately held and publicly traded firms and investigate whether the determinants of cash holdings for both types of firms are similar. Using panel analysis for data we analyze a sample of 9453 private versus 7319 public firms and 104,571 firm-year observations from Central and Eastern Europe over the period 2001–2010. We first show that privately held firms tend to hold more cash than publicly traded firms. Second, firms in more market-oriented countries, according to transition indicators, have larger cash reserves. Third, the same determinants of cash balances are relevant for both privately held and publicly traded firms regardless the stage in the transition to capitalism.     

The relationship between a firm’s information environment and its cash holding decision

This study directly investigates the relationship between the firm’s information environment and its cash holding decision using two separate country-level events as proxies for a general improvement of the information environment: the initial enforcement of new insider trading laws and the mandatory adoption of International Financial Reporting Standards. Analysing a large international sample, we find that firms reduce their cash holdings after both exogenous information shocks. We also find that the reductions are greater for firms facing greater financing constraints and agency issues, and for those for which the informational shocks are stronger. Further analyses reveal a reduction in firms’ average cash savings rate, an increase in performance, an increase in the use of external debt, a decrease in abnormal investment, and an increase in the value of cash holdings. Taken together, our results suggest that an improvement in the information environment mitigates both the adverse selection and moral hazard problems thereby, leading to a reduction in cash reserves held for transaction and precautionary motives, and the likelihood of entrenched managers building large cash balances for private benefit.