Determinants of Corporate Cash Holdings: An Application of Robust Variable Selection Technique

Abstract

US firm cash holdings have become increasingly concentrated over time withering shareholder returns and heightening agency problems associated with free cash flows. Our use of a robust regression technique (LAD) and a state-of-the-art variable selection procedure (LASSO) to identify the determinants of US corporate cash holdings, creates a sparse model which is resistant to outliers. We obtain several results. First, the median of absolute errors of the LAD-LASSO-selected variables is significantly lower than the corresponding values of basic determinants in both in-sample and out-of-sample schemes. Second, financial leverage is a key determinant of cash holdings, indicating that cash and debt policies are tightly related. Third, none of the corporate governance proxies are selected by the LAD-LASSO method challenging what we already know from previous studies regarding the role of these mechanisms in corporate cash management. Our findings help shareholders determine to what extent firm cash levels are excessive, help managers determine their cash needs, and help policymakers predict the aggregate corporate cash demand and formulate policy.