Peer influence and the value of cash holdings

Abstract

We show that a company’s cash holding position relative to the peer group is important for the value of cash holdings. A dollar of cash is valued significantly higher in firms that have cash holdings below the peer group median than in those that do not. The subsample tests show that such peer group benchmarking effect is more pronounced in smaller firms, financially constrained firms, those in industries with higher cash flow volatility, and those facing a highly competitive product market environment. These results are consistent with both information-based and competition-based mechanisms. Furthermore, we find that firms holding below peers’ cash reserves will mimic cash-increasing behavior exhibited by their peers. Crucially, the increased cash holdings will be spent on investment in the subsequent period, and we find that this investment does not hinder firm performance. The main findings in this paper are helpful in understanding the value implications of peer influence. • The value of cash is significantly higher in firms with below peers’ cash holdings. • Peer benchmarking effect is driven by information and industry competition channels. • Firms holding relatively low cash will mimic their peers’ cash-increasing behavior. • The increased cash will be spent on investment which can lead to higher performance.