The Speed of Adjustment of Corporate Cash Holdings

Abstract

Cash is an important and highly liquid asset held by a business firm to meet its liquidity needs and other purposes. Cash holding level bear real consequences on the financial and operating performance and policy of a firm in both short run and long run. In India, there has been a dramatic increase in the corporate cash holdings over the last decade. For the last three years, the percentage of assets that the listed firms are retaining as a cash has undergone an unusal increase. The major purpose of this study is to explore the speed of adjustment of cash balances of sampled firms towards target cash holding. The study sample consists of 849 manufacturing firms listed on National Stock Exchange of India for the period 2007-2012. The present study used dynamic panel data regression analysis to address the dynamic nature of cash holdings, where the generalized method of moments (GMM) technique was employed for estimating the determinants and the speed of adjustment (SOA) of cash holdings with one-step and two-step estimators of system GMM (SYS–GMM) The findings indicate net working capital, leverage, capital expenditure, default spread and T-bills rates have negative association with the cash to total asset ratios while the dividends, net debt issuance and net equity issuance have positive association with cash holding levels of the firm. The estimated adjustment coefficient (λ) is below 0.5 signifying that a typical firm in the sample closes more than half the gap between actual and target cash holdings within one and half year and the entire gap within two and half years. The study results supports trade-off theory of corporate cash holdings. This study provides an insight to the dynamic nature and speed of adjustment towards the target level of cash holdings of sample firms, which might help a finance manager in the better management of cash holdings. Effective liquidity management leads to the realization of long-term financial goals and objectives of a firm.