Level Of Cash Holdings Research Articles

The sub-prime mortgage crisis and the changing value of cash

We use an event study methodology to examine the cross-sectional differences in the marginal value of cash before and during the sub-prime mortgage crisis. We document that the marginal value of cash is significantly lower in the crisis period than in the pre-crisis period. Additionally, for the pre-crisis period, we find an inverse relation between the level of cash holdings and the marginal value of cash. Our results still hold after segregating our sample into constrained and unconstrained groups.

Accruals quality and corporate cash holdings

AbstractThis Work Uses Panel Data For Firms Listed In The Spanish Stock Exchange Over The Period From 1995 To 2001 To Analyse The Effect Of Accounting Quality On Cash Holdings. The Results Show That Firms With Good Accruals Quality Hold Lower Cash Levels Than Firms With Poor Accruals Quality. This Finding Suggests That The Quality Of Accounting Information May Reduce The Negative Effects Of Information Asymmetries And Adverse Selection Costs, Allowing Firms To Reduce Their Level Of Corporate Cash Holdings. The Results Also Show That Cash Holdings Decrease When Firms Increase Their Use Of Bank Debt And In The Presence Of Cash Substitutes. In Contrast With This, Firms With Higher Cash Flow Hold Higher Levels Of Cash.

Corporate Governance and Cash Holdings: Listed New Economy versus Old Economy Firms

ABSTRACTManuscript Type: EmpiricalResearch Question/Issue: This study examines the impact of corporate governance on the cash‐holding policies of firms with different investment opportunities. It is difficult to determine the optimal level of cash holdings for “listed new economy” firms (firms in the computer, software, Internet, telecommunications, or networking industries), which require large amounts of capital for investment opportunities with high return potential. Unlike in “old economy” firms, for which investment opportunities are relatively limited, corporate governance in listed new economy firms may create shareholder protections that make investors willing to accept higher levels of corporate cash holdings.Research Findings/Results: By examining American Standard and Poor 1,500 companies, the evidence shows that CEO ownership and board independence affect the cash holdings in listed new economy and old economy firms differently. Specifically, higher managerial cash holdings tend to reduce cash holdings in old economy firms and higher board independence tend to increase cash holdings in listed new economy firms.Theoretical Implications: This study provides empirical support for the association between agency theory and cash theories. Given different firm characteristics, the impact of corporate governance on cash holdings verifies the implication of agency theory in explaining corporate cash policy.Practical Implications: While firms in new economy industries may be eager for more flexible governance codes in order to maintain the freedom of decision making, the evidence from this study suggests that establishing effective governance mechanisms may, in turn, effectively enlarge the degree of freedom for these firms to make timely business decisions.

Alignment or entrenchment? Corporate governance and cash holdings in growing firms

This study contends that the association between corporate cash holdings and corporate governance is subject to the investment environments that firms face. For example, firms with an abundance of investment opportunities have a strong incentive to hold cash in order to maintain their competitive positions. Shareholders accept high levels of cash holdings in such growing firms if corporate governance can protect their interests. This study examines the effects of corporate governance on cash holdings for a sample of high-tech firms. The results show that CEO ownership, the directorship of venture capitalists (VCs), and independent directors play critical roles in corporate cash policy. In addition, the boards are more effective when the firms' CEOs are also their founders or when VCs hold a large stake of company shares. The effects of corporate governance are more significant in younger firms while the effects of firm-specific economic variables are more significant in older firms in the sample.

Corporate Cash Policy and How to Manage it with Stock Repurchases

At the end of 2004 total U.S. corporate cash holdings reached an all‐time high of just under $2 trillion—an amount equal to roughly 15% of the total U.S. GDP. And during the past 25 years, average cash holdings have jumped from 10% to 23% of total corporate assets. But at the same time their levels of cash have risen, U.S. companies have paid out dramatically increasing amounts of cash to buy back shares.This article addresses the following questions: What accounts for the dramatic increase in the average level of corporate cash holdings since 1980? And why do some companies keep so much cash (with one fourth of U.S. firms holding cash amounting to at least 36% of total assets) while others have so little (with another quarter having less than 3%)? Why do companies pay out excess cash in the form of stock repurchases (rather than, say, dividends), and what explains the significant increase in repurchases (both in absolute terms and relative to dividends) over time?The author begins by arguing that cash reserves provide companies with a buffer against possible shortfalls in operating profits—one that, especially during periods of financial trouble, can be used to avoid financial distress or provide funding for promising projects that might otherwise have to be put off. Such buffers are particularly valuable in the case of smaller, riskier companies with lots of growth opportunities and limited access to capital markets. And the dramatic increase in corporate cash holdings between 1980 and the present can be attributed mainly to an increase in the risk of publicly traded companies—an increase in risk that reflects in part a general increase in competition, but also a notable change over time in the kinds of companies (smaller, newer, less profitable, non‐dividend paying firms) that have chosen to go public.At the other end of the corporate spectrum are large, relatively mature companies with limited growth opportunities. Although such companies tend to produce considerable free cash flow, they also tend to retain relatively small amounts of cash (as a percentage of total assets), in part because of shareholder concern about the corporate “free cash flow problem”—the well‐documented tendency of such companies to destroy value through overpriced (often diversifying) acquisitions and other misguided attempts to pursue growth at the expense of profitability.For companies with highly predictable earnings and investment plans, dividends provide one means of addressing the free cash flow problem. But for companies with more variable earnings and less predictable reinvestment, open‐market stock repurchases provide a more flexible means of distributing cash to shareholders. Unlike the corporate “commitment” implied by dividend payments, an open market stock repurchase program creates what amounts to an option but not an obligation to distribute funds. The value of such flexibility, which increases during periods of increased risk and uncertainty, explains much of the apparent substitution of repurchases for dividends in recent years.

Corporate Cash Holdings and the Cross-Sectional Variation in Asset Returns

The level of cash holdings varies significantly across firms. As a low-returning asset, previous literature has theorized that holding excess cash should harm firm value. We find that this appears to be true amongst large firms. However, amongst small firms, we find that market returns rise with cash ratios (cash/assets or cash/market cap). These higher returns are not due to any known risk factors. Additionally they are accompanied by superior operating performance – higher growth in assets and growth in cash flow. Evidence supports the theory that the outperformance results from the easing of financial constraints upon these firms. The results are most robust for small, growth-oriented firms, who have the most difficulty accessing capital markets and could benefit the most from holding cash.

On the Determinants of SME Cash Holdings: Evidence from Spain

Abstract: This work analyses the factors that might explain the level of cash holdings in a sample of 860 small and medium‐sized firms from Spain during the period 1996–2001. The empirical results show that firms have a target cash level to which they attempt to converge. The level of this target is higher for firms with more growth opportunities and larger cash flows. In contrast, the target level for cash holdings falls when the use of bank debt and the presence of substitutes for cash increase. Moreover, when the interest rates in the economy increase firms reduce their cash holding.

Cash Holdings in Finnish SMEs

This paper examines the determinants of cash holdings in a sample of Finnish small and micro firms. Our results suggest that lending relationships and the share of managerial ownership both have a significant impact on cash holdings. The results on the relationship lending variables indicate that using multiple banks reduces the level of cash holdings. This suggests that firms with not so tight relationships with their banks have easier access to funds and therefore less need for cash holdings. The results also suggest that a similar effect can be achieved by building long-term bank-borrower relationships in cases where the firm has outstanding loans from one bank at the most. The results on managerial ownership variables indicate that the relationship between cash holdings and managerial ownership is cubic but that this result only holds for the larger firms in the sample and for the firms that borrow from two or more banks. Furthermore, our results show that larger firms, firms facing financial constraints and firms with high debt to assets ratios all hold more cash.

Firm Structure & Corporate Cash Holdings

We analyze whether organizational structure of firms (i.e., whether a firm is diversified or focused) affects corporate cash holdings. Focusing on organizational structure allows us to throw light on the non-governance related factors that affect cash holdings, which complements the recent spate of research on the impact of governance mechanisms on cash policy. There are several reasons why firm structure could affect cash holdings. We examine three hypotheses, the complementary growth, asset sales, and influence cost hypotheses. First, in diversified firms, since the time-series of investment opportunities for different segments may not be perfectly correlated, the total cash need for a diversified firm may be less volatile over time. If firms hold cash for potential growth needs, diversified firms would need less to meet the investment need at any one point in time. Additionally, if there is an active internal capital market within diversified firms, the cash flow of one segment is available as capital for another segment. This reduces the need of external capital thereby reducing a benefit of holding cash. Second, diversified firms are more likely than single-segment firms to be able to raise funds by selling substantial assets, especially assets of non-core segments. This reduces the benefits of cash holdings. Hence, firms with more than one segment should have lower levels of cash holdings. Finally, a particular type of agency problem, the influence costs, that arise from segment-managers' value-dissipating competition for firm-wide resources is more severe among diversified firms than single segment firms. Thus the marginal cost of holding cash and liquid assets, which generate these influence costs, are higher for diversified firms than for focused firms. Hence, we would expect diversified firms to hold less cash. All three hypotheses predict that diversified firms will have less cash holdings than their stand-alone counterparts. Using Compustat financial and segment data in the 1988-2002 period, we find evidence that diversified firms hold significantly less cash than their focused counterparts. This result holds even after industry adjustment at the segment level, and after controlling for the different factors found to be important determinants of corporate cashing holdings in the extant literature. Using time-series, cross-sectional, and additional robustness tests, we are able to attribute the lowered optimal cash holdings among diversified firms to the presence of internal capital markets, and the potential for asset sales among these firms.

A NOTE ON THE USELESSNESS OF TRANSACTION DEMAND MODELS*

CASE M. SPRENKLE (1969), in a refreshing departure from elasticitygrubbing that constitutes most empirical work on money demand, examined predicted vs. reported levels of cash holdings in firms, using equation derived by Baumol (1952) and Tobin (1956) as his predictor. Sprenkle concluded that compensating balance requirements, and not asset management decisions taken to cover transaction needs, are most important data in explaining amount of cash held by business firms. In this note, I argue that his results do not support his claim of showing the uselessness of transaction demand models. Rather, they stem from (a) inadequacy of Baumol-Tobin (B-T) model as a representation of cash flows, and (b) irrelevance of cash balance data contained in financial reports to empirical research on money holdings. I also show that Sprenkle's heavy reliance on importance of compensating balances is misplaced. II. TRANSACTIONS DEMAND MODELS AS PREDICTORS He sets out to show little . . . [the B-T model] . . . really explains, how subject to error results of theory are, and how fruitless more sophisticated versions of theory are apt to be. He shows that model does a poor job of predicting level of cash holdings in large business firms, and concludes with obiter dictum that compensating balances determine levels of business cash holdings. The Baumol-Tobin model depicts cash flow as a sequence of k receipts per year, each one being followed by a steady stream of payments which just exhaust it. That representation is a priori unreasonable. A large part of any firm's cash transactions are with other firms, so few firms, if any, can show cash flow pattern assumed in B-T model. Also, direct evidence from a few firms shows a random mixture of odd-sized daily net receipts and payments. In those observed cases, running mean of daily cash activity rapidly converges to a value close to zero; daily flows have no significant underlying periodicity, and certainly no trend or drift.' The B-T model, by contrast, assumes that cash account level is extremely periodic, if it is left unadjusted. * NSF research support is gratefully acknowledged. This note is a spin-off from a longer paper that has been presented before several helpful audiences. Thanks are owed to R. Clower, M. Darby, J. Kindahl, A. Leijonhufvud, L. Meyer, R. Schmalensee, C. Sprenkle, and Jack M. Guttentag, for useful comments. The usual disclaimer on sources of error applies. ** Professor of Economics, University of California, San Diego. 1. One day is ideal interval at which to observe cash flows, since returns on short-term securities can be realized on a daily basis, and banks monitor demand deposit accounts of their customers once per day.