Cash holding, trade credit and access to short-term bank finance

Abstract

Since 1988, cash holding of the UK companies has increased from 10.6% to 16.4% of total assets. To explain this increase, we develop a panel vector autoregression and analyse the dynamics between cash holding and its closest substitutes, trade credit and short-term bank finance. Impulse response functions confirm the signalling theory, as trade credit facilitates access to bank finance. Firms experiencing liquidity shocks resort to cash or trade credit but not to bank finance. Cash holding improves access to trade credit. Additional cash and trade credit trigger a slowdown of the cash conversion cycle explained by agency theory. Cash-rich firms have accumulated more cash than predicted because of an unexpected decline in short-term debt, stressing the role of banks in explaining the increase in cash holding.