Geopolitical risk and corporate cash Holdings in China: Precautionary motive and agency problem perspectives

Abstract

Using a sample of Chinese A-share listed companies, we investigate the relationship between geopolitical risk and corporate cash holdings, integrating two contrasting theories—precautionary motive and agency problems—into the analysis. To explore our core findings about the negative impact of geopolitical risk on cash holdings, we examine the cash flows of operating, investing, and financing activities. We find that corporations strategically reduce cash flow from financing activities and increase dividend distributions to alleviate agency problems when geopolitical risk rises. In contrast, geopolitical risk does not significantly affect the cash flow from operating activities, whereas the cash flow from investing activities increases. The overall adverse effect of geopolitical risk on cash holdings reflects the incentive to mitigate agency problems. This is valued by external shareholders, alleviating the negative impact of geopolitical risk on firm value. However, corporations also adopt precautionary actions by increasing their credit loans to defend against potential liquidity risk. Additionally, we document that corporations with high board independence and those in regions with high marketization diminish more cash when geopolitical risk rises, with non-state-owned corporations, overinvested corporations, and corporations with low financial constraints particularly negatively affected by geopolitical risk. Our results withstand rigorous robustness tests, shedding light on the intricate dynamics of corporate financial decisions amidst geopolitical risk and offering a fresh perspective to the corporate governance literature.