Real option component of cash holdings,business cycle,and stock returns |
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| Institution: | 1. School of Accounting and Finance, University of Adelaide, Australia;2. Department of Economics and Finance, University of Arkansas at Little Rock, USA;3. International Institute for Financial Studies and RCFMRP, Jiangxi University of Finance and Economics, China;1. The Department of Economics and Finance, The University of Arkansas at Little Rock, United States;2. The Department of Economics and Finance, West Chester University, 411 Business and Public Management Center, 50 Sharpless St., West Chester, PA, 19383, USA;1. Department of Finance, Suffolk University, Boston, MA 02108, United States;2. Department of Marketing and Finance, Frostburg State University, Frostburg, MD 21532, United States;1. School of Management, University of Bath, Bath BA2 7AY, United Kingdom;2. Cardiff Business School, Cardiff University, Cardiff CF10 3XQ, United Kingdom;1. Anderson School of Management, University of New Mexico, Albuquerque, NM 87131, United States;2. Department of Finance, National Chengchi University, NO.64, Sec.2, ZhiNan Rd., Wenshan District, Taipei City 11605, Taiwan;3. Department of Finance and Risk and Insurance Research Center, National Chengchi University, NO.64, Sec.2, ZhiNan Rd., Wenshan District, Taipei City 11605, Taiwan |
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| Abstract: | Corporate managers tend to preserve cash with an expectation of a worse economy while spend cash to exercise growth opportunities with a favorable economic condition. Using three empirical proxies (book-to-market ratio, idiosyncratic volatility and return on asset) in the literature, we extract a real option component of corporate cash holdings, serving both functions of precautionary saving and exercising growth options. Our empirical results show this component, in aggregate, increases when the real GDP declines and decreases when GDP inflates. Also, stocks with returns declining more to a shock to the aggregate real option component of cash holdings earn higher future returns. Moreover, stock returns of firms with higher cash holdings positively comove with the shock to the aggregate real option component, suggesting investors prefer to hold firms with higher cash holdings when the economy is deteriorating. |
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