Why Do Private Firms Hold Less Cash than Public Firms? International Evidence on Cash Holdings and Borrowing Costs

Abstract

We contend, with aid of a stylized model, that high borrowing costs can overwhelm precautionary motives and induce low cash holdings in private firms. Supportive of our hypothesis, we find European private firms hold less cash than public firms and this pattern reflects differential borrowing costs. Results are robust to endogeneity concerns and reveal private firms use cash flow to pay-down existing debt instead of building cash reserves; private firms are also less sensitive to precautionary reasons for holding cash. Further, stronger creditor rights and debt market development lead to convergence in cash policies of public and private firms.