How and Why Do Firms Adjust Their Cash Holdings toward Targets? Evidence from China

Abstract

We examine the dynamic adjustment of cash holdings of publicly traded Chinese firms during 1998–2006. The empirical evidence is supportive of the dynamic trade-off theory of cash holdings. In particular, there is strong evidence of asymmetric adjustments, i.e., adjustments from above the target are significantly faster than those from below. Moreover, the speeds of adjustment (SOA) are heterogeneous for firms facing differential adjustment costs. More specifically, the adjustment speed is higher in firms with bank lines of credit, positively related to the deviation from the target, but it is negatively related to firm size. Furthermore, in terms of adjustment method, firms make adjustments to their targets primarily through debt and equity financing when they are in cash shortage, On the other hand, the dividend payments play a minimal role in it. Lastly, in terms of motives for adjustment, we find that the precautionary motive arising from financial constraints well explains the cash holdings adjustment behaviors of Chinese listed firms