Cash Holding, Trade Credit and Access to Short-Term Bank Finance

Abstract

Since 1988, cash holding of UK listed companies increased from 10.6 to 16.4%. Focusing on the short-term view of cash holding and its substitutes, trade credit and short-term bank finance, the study develops a panel vector autoregression that accounts for firm-specific liquidity needs based on the cash conversion cycle. Impulse response functions confirm the signalling theory of trade credit and show that firms experiencing liquidity shocks resort to cash or trade credit but not to bank finance. Increasing cash improves access to trade credit. Additional cash or trade credit triggers a slowdown of the CCC, which could be explained by agency theory. Managers are reluctant to make the effort to improve working capital management if short-term funding is secured. The model can predict cash holding for the average firm; however, cash-rich firms cumulate more cash than predicted, which is due to an unexpected decline in bank finance and trade credit.