The Demand for Liquid Assets: A Firm Level Analysis

Abstract

Analysts have exerted considerable effort attempting to demonstrate that the demand for liquid assets (or money) conforms to microeconomic theory. The theory itself is splintered along three lines of inquiry-a Keynesian version stressing the transaction and asset motives [28; 33; 35]; an essentially quantity theory approach [19; 6]; and an approach which incorporates money into the firm's production function [22; 31; 7; 29]. The empirical work used to test these theoretical approaches has a common element-a measure of the firm's scale is included (usually sales or business receipts)-and generally a common flaw-the use of aggregated data. Most studies have used industry level data because it is more readily available. This forces the analyst to assume that firms within an industry are homogeneous while firms across industries are heterogeneous. The authors can then use the firm as the unit of analysis. The typical is a hypothetical construct whose characteristics are statistical means of all firms aggregated within the industrial category. While this is a useful assumption, the aggregation may hide the influence of the distribution of firms within the industry. These distributional impacts may be significant if there are substantial economies of scale or if size influences such things as cash management practices and access to financial markets. Katsimbris and Miller [15] have warned that the size distribution of firms within an industry may alter money demand: the greater the inequality in sales the lower the industry's demand for money. They find no support for the assumption of identical structural specification across industries. These observations have been echoed by Hunter [12] and by other work of Katsimbris and Miller [13; 14]. Under such circumstances, the use of industry-average data may yield misleading conclusions on the demand for money. Any study of behavior in this area should, at the very least, control for industry. Some time ago Vogel and Maddala [33] called for empirical studies using firm-level data, a call which has gone largely unanswered. This study attempts to fill this void by using a comprehensive set of firm-level data over a five-year period. But we also attempt to answer several other questions. Does the presence of foreign ownership alter the firm's demand for liquid assets?