Corporate precautionary cash holdings |
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| Institution: | 1. Shanghai Advanced Institute of Finance, Shanghai Jiaotong University, Shanghai, China;2. Henry B. Tippie College of Business, University of Iowa, Iowa City, IA 52242, United States;1. Istanbul Medeniyet University, Ünalan Mah. Ünalan Sok., D-100 Karayolu Yanyol, 34700, Üsküdar, ?stanbul, Turkey;2. Istanbul Technical University (ITU), Macka 34367, Istanbul, Turkey;1. School of Business, Renmin University of China, Beijing 100872, China;2. Department of Finance, Gordon Ford College of Business, Western Kentucky University, Bowling Green, KY 42101, USA;1. University of International Business and Economics, China;2. Beijing Foreign Studies University, China;3. Cardiff University, UK;4. Faculty of Business and Economics, University of Hong Kong, Hong Kong |
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| Abstract: | 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. |
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