Abstract
Do firms with liquid stocks hold more cash? If so, why? We show that liquidity has a positive effect on the level and value of cash holdings. Using a regression discontinuity design based on the Russell 1000/2000 index reconstitution, we also show that there is a causal link between liquidity and cash holdings. These findings are consistent with a view predicting that high liquidity generates the complementarity between external financing and cash holdings. Furthermore, we show that the positive effect is more pronounced for firms with more growth opportunities, suggesting that liquidity increases cash holdings by expanding investment opportunities.
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