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.     

Multinationals and cash holdings

This study examines the relationship between cash holdings and the level of multinationality for a large international sample of firms from 40 countries. We consider two dimensions of diversification, geographical and industrial, and find a direct negative relation between both geographic and industrial diversification and cash holdings. This finding is consistent with the diversification argument that multinationals' headquarters plan their investment and cash needs in an efficient way across geographically diversified operations. We further examine whether there is a trade-off between two diversification strategies. The evidence shows that the effect of industrial diversification is negligible once firms are geographically diversified. By performing country-level tests, we also document some new evidence of international differences for the impacts of tax systems, investor protection, political stability, stock market development, economic size and growth, and national culture on the separate and joint effects of geographic and industrial diversifications.     

Trust and corporate cash holdings

We examine the relation between the level of trust in a country and corporate cash holdings. The precautionary savings motive predicts that firms located in countries with less trusting societies will hoard more cash in order to compensate for reduced access to capital markets. The agency hypothesis predicts that shareholders in countries with low levels of societal trust will pressure firms to disgorge cash. The first theory predicts a negative relation between trust and corporate cash holdings while the second theory predicts a positive relation between these two variables. Using data on firms located in 54 countries around the world, we find evidence in favor of the agency-based explanation for the relation between trust and corporate cash holdings. Overall, our results highlight the role played by informal institutions in shaping corporate financial management.     

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.     

Firm structure and corporate cash holdings

We analyze whether the organizational structure of firms (i.e., whether a firm is diversified or focused) affects their cash holdings. Using Compustat firm level and segment-level data, we find that diversified firms hold significantly less cash than their focused counterparts. Our results are robust to industry adjustments at the segment level and to different factors previously found to be important determinants of cash holdings. Using time-series, cross-sectional, and additional robustness tests we are able to attribute the lower cash holdings among diversified firms to complementary growth opportunities across the different segments of these firms and the availability of active internal capital markets. We find that the other theories that rely on the potentially effective use of asset sales of non-core segments of diversified firms to generate cash, and the increased agency/influence costs in diversified firms do not offer an economically significant explanation for the lower cash holdings among diversified firms.     

Firm selection and corporate cash holdings

Since the early 1980s, the composition of US public firms has progressively shifted toward less profitable firms with high growth potential (Fama and French, 2004). We estimate a dynamic corporate finance model to quantify the role of this selection mechanism for the secular trend in cash holdings among US public firms. We find that an increase in the precautionary savings motive—primarily driven by the decline in initial profitability among R&D-intensive new lists—explains about 50% of the upward trend in cash holdings. This selection mechanism also explains part of the upward trend in sales growth volatility.     

Corporate cash holdings and political connections

We examine the relation between corporate liquidity and political connections measured via lobbying expenditures. This is an interesting question as many of the motives for holding cash should be diminished by political connections. Results indicate a significant and inverse relation between cash levels and lobby expenses and that the marginal value of cash decreases with lobbying. Taken together, these findings suggest firms react optimally to the reduced benefits of cash linked to political connections and that the market recognizes the weakened benefits of cash. Overall, our research shows another way political connections can shape corporate policy.     

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.     

Organization capital and corporate cash holdings

This paper investigates the relationship between organization capital and corporate cash holdings. We develop two competing hypotheses in relating organization capital with cash holding. Our analysis reveals that organization capital is related to high levels of cash holdings. Moreover, we find that the effect of organization capital on corporate cash holdings is stronger for firms experiencing high levels of financing constraint and cash flow risk. Our results remain robust to alternative measures of organization capital and corporate cash holdings, and are not driven by omitted variable bias or endogeneity issues. We also find that the positive relation between organization capital and cash holdings is not confounded by sample period or industry group. Overall, we provide robust evidence that supports the precautionary motive for corporate cash holding.     

Accruals quality and corporate cash holdings

This Work Uses Panel Data For Firms Listed In The Spanish Stock Exchange Over The Period From 1995 To 2001 To Analyse The Effect Of Accounting Quality On Cash Holdings. The Results Show That Firms With Good Accruals Quality Hold Lower Cash Levels Than Firms With Poor Accruals Quality. This Finding Suggests That The Quality Of Accounting Information May Reduce The Negative Effects Of Information Asymmetries And Adverse Selection Costs, Allowing Firms To Reduce Their Level Of Corporate Cash Holdings. The Results Also Show That Cash Holdings Decrease When Firms Increase Their Use Of Bank Debt And In The Presence Of Cash Substitutes. In Contrast With This, Firms With Higher Cash Flow Hold Higher Levels Of Cash.     

CEO overconfidence and corporate cash holdings

This study proposes chief executive officer (CEO) overconfidence to be an alternative explanation to corporate cash holdings. We find positive effects of CEO overconfidence on the level of cash holdings and the value of cash, which are mainly due to the investment environments faced by firms. The positive effects of CEO overconfidence on cash holdings level and cash value are barely affected by the traditional motives of cash holdings based on trade-off and agency theories. The analysis of cash sources further explains why firms with overconfident CEOs can aggressively pursue risky investments and maintain large cash holdings at the same time. Although the prior literature indicates that overconfident CEOs tend to avoid equity issues for their capital investments, the contribution to cash savings from equity is higher than that from debt. Additional robustness tests also support our empirical findings.     

Credit risk spillovers and cash holdings

This paper examines how credit risk spillovers affect corporate financial flexibility. We construct separate empirical proxies to disentangle the two channels of credit risk spillovers—credit risk contagion (CRC), where one firm's default increases the distress likelihood of another; and product market rivalry (PMR), where the same default strengthens the position of a competitor. We show that firms facing greater CRC have weaker subsequent operating performance and must contend with less favorable bank loan terms. Meanwhile, they accumulate more cash by issuing equity, selling assets, and reducing investment and payout. In contrast, PMR generally has opposite, albeit weaker, effects. Our findings suggest that credit risk spillovers, especially CRC, play an important role in corporate liquidity management.     

Earnings quality and corporate cash holdings

Poor earnings quality exacerbates information asymmetry between internal and external stakeholders of a firm. Agency considerations then persuade investors to discount the value of corporate cash holdings out of concern about the inappropriate use of funds. In this study, we show that poor earnings quality has a negative impact on the value of corporate cash holdings and a positive impact on the level of cash reserves. We find that the negative effect of poor earnings quality either neutralizes or more than offsets the positive effect of excess cash on firm value. Our results are robust to several measures of earnings quality and model specifications.     

Customers and cash: How relationships affect suppliers' cash holdings

If one customer accounts for a large portion of a supplier's sales, then the loss of that one customer can cripple the supplier's financial health. As a precaution against the additional operating risk induced by being in an important relationship with a customer, I find that suppliers in such relationships hold more cash on average than suppliers that are not in important relationships. Additionally, supplier's cash holdings increase proportionately with the importance of their customer relationships. Being in an important relationship affects cash holdings and leverage differently, indicating that firms manage cash and debt for different purposes. I find that suppliers in relationships primarily accrue cash through issuance of stock as opposed to debt or retained earnings. The results highlight the importance of understanding buyer–supplier relationships when evaluating a firm's financing policy.     

CEO cultural background and corporate cash holdings

This paper examines whether the cultural background of chief executive officers (CEOs) affects corporate cash holdings. Using UK data from 2000 to 2018, we find that CEOs with a cultural background that emphasises power distance and uncertainty avoidance are positively associated with corporate cash holdings, while CEOs with a cultural background that emphasises masculinity are negatively associated with corporate cash holdings. Our results are robust to various robustness tests. Further analyses show that the impact is more pronounced when power is concentrated among top executives, when the CEOs have a degree of discretion in pursuing their own goals, and when information asymmetry is high.     

Employee protection shocks and corporate cash holdings

We examine the relation between employee protection legislation and corporate cash holdings. Our rationale rests on the notion that higher labor adjustment costs increase a firm's operating leverage making firms to adjust their liquidity management by increasing precautionary savings. Consistent with this, we show that the staggered passage of legal exceptions to the “at-will” employment doctrine in various U.S. states led to an average increase in cash holdings by 7.2%. Cash increases are higher when unionization rates and industry concentration are lower, and when industry discharge rates and volatility is higher. Consistent with the financial flexibility argument of tighter employment protection increasing corporate cash needs, the value of cash increases after the passage of pro-labor regulations. Moreover, we find that the increase in the value of cash is especially pronounced for financially constrained firms.     

CEO organizational identification and firm cash holdings

As the decision-makers and implementers of a firm’s financial strategy, executives play a critical role in cash holding activities, and their psychological characteristics have a major impact on cash holdings. This paper investigates the association between CEO organizational identification and firm cash holdings. The empirical results show that CEO organizational identification is negatively associated with firm cash holdings, and the negative association is more pronounced when the level of financial development is higher and economic uncertainty is lower. Further analysis reveals that the higher a CEO’s organizational identification, the higher the firm’s R&D investment and capital expenditure, and high CEO organizational identification can increase the value of firm cash holdings. Overall, our findings supplement the literature on organizational identification and cash holdings, and on the effect of executives’ psychological characteristics on corporate financial decision-making.     

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.

Corporate cash holdings: Causes and consequences

The considerable growth in corporate cash holdings around the world has prompted scholarly interest. Consequently, there is now a large academic literature examining cash holdings and their impact on corporate outcomes and firm values. This article reviews and synthesizes the literature to offer insight into two primary motives to hold cash: precautionary and agency. We first present a stylized model that explores the trade-off in holding cash between these two motives and then examine empirical studies to determine how existing theories are supported by evidence using data from a variety of countries. In addition, we examine the effectiveness of a variety of corporate governance devices in curtailing cash holdings and also the extent to which these devices offer investors' confidence that cash will not be wasted. Finally, we discuss methodological and measurement issues associated with empirical cash holdings studies.     

Corporate cash holdings and CEO compensation incentives

We examine the effect of chief executive officer (CEO) compensation incentives on corporate cash holdings and the value of cash to better understand how compensation incentives designed to enhance the alignment of manager and shareholder interests could influence stockholder-bondholder conflicts. We find a positive relation between CEO risk-taking (vega) incentives and cash holdings, and we find a negative relation between vega and the value of cash to shareholders. The negative effect of vega on the value of cash is robust after controlling for corporate governance, is stronger in firms with high leverage, is reversed for unlevered firms, and is not present in financially constrained firms. We also find that the likelihood of liquidity covenants in new bank loans is increasing in CEO vega incentives. Our evidence primarily supports the costly contracting hypothesis, which asserts that bondholders anticipate greater risk-taking in high vega firms and, therefore, require greater liquidity.