Corporate Cash Policy Research Articles

Local Gambling Preference and Corporate Cash Policy

This paper studies the relation between local attitudes towards gambling and corporate liquidity. I find that firms exposed to stronger gambling preference hold significantly more cash, because cash enables them to take more risk while staying away from financial distress. Furthermore, I show that gambling-prone firms hold more cash only when they are financially constrained, and these firms also have higher marginal value of cash holding. Corporate headquarter relocation confirms the causal impact of gambling preference on cash holding. Taken together, these findings suggest that greater cash holding in gambling-prone firms is a value-increasing policy due to their strong risk-taking incentive.

Do Local Protestant Values Affect Corporate Cash Holdings?

This study examines how local Protestant belief, as one type of social norms, affects corporate cash policies. We find that firms located in areas with more Protestants hold less cash reserves. The influence of local Protestant belief on cash holdings is more profound for firms with weak corporate governance and firms with one geographic segment. In addition, we find that the difference in cash deployment is reflected in the difference in firms’ investment and payout policies. Overall, our study shows that local Protestant belief is an important factor in determining corporate cash policies and helps to mitigate the potential free cash flow problem.

Financial Flexibility and Corporate Cash Policy

Financial Flexibility and Corporate Cash Policy

Financial Liberalization and Corporate Cash Policy

Financial Liberalization and Corporate Cash Policy

How Do Chief Financial Officers Affect Corporate Cash Policies?

This paper examines the extent to which Chief Financial Officers (CFOs) affect corporate cash holding policies. We construct an index (CFO index) that enables us to distinguish between strong'' and weak'' CFOs based on their ability to influence firm outcomes. We find that firms with strong CFOs hold substantially less cash than firms with weak CFOs, ceteris paribus. Importantly, the CFO effect documented in our study goes beyond the effect caused by the Chief Executive Officer (CEO) on cash holdings. Our findings provide the first direct empirical evidence that firms with strong CFOs are well positioned to hold less cash due to their relatively weak precautionary motive and superior ability to raise external financing during periods of financial stress.

Do bank lending relationships affect corporate cash policy?

Purpose The purpose of this paper is to examine whether prior bank lending relationships affect firms’ liquidity management. Design/methodology/approach The authors mainly work on evaluating first, whether prior lending relationships affect corporate cash holdings? and second, whether the cash flow sensitivity of cash varies systemically with lending relationships. Three different ways are used to define lending relationships, including the lending relationship dummy, a firm’s maximum relationship intensity in terms of number of deals across all lenders and a firm’s maximum relationship intensity in terms of dollar amounts across all lenders. In addition, the paper applies two-stage least squares (2SLS) to address the concern of endogeneity between firms’ liquidity management and banking relationships. Findings The authors find that firms with lending relationships maintain a lower level of cash holdings and save less cash out of cash flow. Furthermore, the effect of lending relationships is more profound for firms with high cash flow. The results suggest that prior lending relations alleviate information asymmetry, lower the cost of capital and therefore affect firms’ propensity to retain cash and maintain a high level of cash holdings. Research limitations/implications This paper contributes to both the liquidity management literature and the literature on the value of maintaining lending relationships with banks. Researchers should take into consideration the lending relationships built over the course of the lending when assessing firms’ cash policies. Social implications Bank lending relationship mitigates the information asymmetry problem, one type of market friction, and facilitates firms’ future external financing, thereby affecting firms’ cash policies and giving more flexibility in liquidity management. The value of lending relationships distinguishes bank loans from public bonds. Therefore, firms, especially those facing more information asymmetry issue, should take into account the benefits from lending relationships in their future debt financing. Originality/value Extant literature examines how firm characteristics affect firms’ cash holdings. This paper introduces a new factor that could explain corporate cash policy.

A Theory of Liquidity, Investment and Credit Risk for Financially Constrained Firms

This paper builds a dynamic capital structure model of the firm with costly external financing and long term debt, and studies the joint interactions between a firm's corporate cash policy, investment policy and strategic default risk. Investment takes the form of a real option and is both costly and irreversible. Firms hold cash both as a precaution against default and costly equity issuance, as well as to fund investment. The resulting setup is tractable, delivers the prices of equity and in closed form, and yields a number of rich insights: (i) Optimal cash and investment policies take the form of threshold rules that are a function of firm capital stock, default risk and earnings fundamentals. (ii) A rise in strategic default risk mitigates both the incentive to hold cash and the incentive to invest. This can explain why cash holdings rose more for less levered firms while investment fell for smaller, more levered firms during the crisis. (iii) The relationship between cash and capital when investing is affected by credit risk, with the cash needed to invest falling with capital for firms close to default, and rising with capital otherwise. (iv) An increase in volatility of the real option results in increased cash holdings, lower dividends and lower equity value prior to investment - contrary to the standard growth - option literature. (v) Firms with high market-to-book ratio hold less cash than other firms when far from default, but this relationship reverses as default risk rises. (vi) Optimal cash holdings as a function of capital is U-shaped and increases close to default and when the firm invests. (vii) When external financing becomes more costly, it lowers the optimal leverage choice of firms, which is consistent with the debt conservatism puzzle. Finally, the paper verifies that the predictions of the model are supported in the data.

A State-of-the-Art Review of Corporate Cash Holding Research

This review provides several contributions to current research on the determinants of the corporate cash level and its effects on company value. First, the extensive theoretical basis of the corporate cash policy is disentangled. Respective empirical studies consider only a subset of the total theoretical framework. It is therefore valuable to establish an overview of the entire set of theories and to discuss their connections and overlap. I distinguish three theories that stem from capital structure research. These are the trade-off theory, the pecking-order theory and the FCF-hypothesis. Besides, four cash holding-specific theories, namely the liquidity constraints theory, the defense against hostile takeovers theory, the hedging perspective and the costly contracting theory, are regarded. The current trend of investigating cash holdings and the diversity of the associated theories result in a wide set of heterogeneous studies. Thus, the second contribution of this review is to identify the most common proxies used in empirical research, aggregate them into general categories of determinants and compare their predicted influence according to different theories. In sum, 12 general determinants, such as firm size, growth opportunities, leverage, liquidity substitutes and corporate governance, are found to influence corporate cash holdings. A third contribution is provided by establishing a comprehensive review of the actual empirical influence of these determinants and comparing it to their predicted theoretical association.

Can I Trust You with My Money? The Role of Social Trust in Corporate Cash Policy

We examine how corporate cash policy is related to the level of social trust in a country, with trust defined as the subjective probability that an individual assigns to the event of a potential counter-party performing an action that is beneficial or at least not harmful to that individual. We explore two competing hypotheses. On the one hand, in a high-trust country, shareholders are less concerned about managers abusing corporate cash resource for personal gains and therefore allow firms to maintain larger cash holdings. On the other hand, the reduced concern about managerial moral hazard in high-trust countries increases investors’ willingness to provide capital to firms. The resultant greater accessibility of external finance weakens firms’ precautionary saving motive and leads to lower corporate cash reserve. Our analysis of a large sample of firm-year observations from 41 countries supports the first hypothesis. Specifically, corporate cash holding is significantly and positively related to a country’s level of social trust. In addition, consistent with a substitutive relation between subjective belief and formal rules and regulations, the impact of trust is more pronounced in countries with poorer investor protection and weaker legal enforcement. We also observe an elevated effect of trust following negative shocks to investors’ confidence in formal institutions created by high-profile corporate scandals. Finally, we find that the market value of corporate cash holding is significantly higher in high-trust countries. Overall, our results highlight the importance of social trust as an informal institution in influencing corporate cash policy.

Technology spillovers and corporate cash holdings

This study examines the effect of technology spillovers on firms׳ cash holdings. It finds that firms facing greater technology spillovers hold higher cash balances. This effect is more pronounced among financially constrained firms and for firms that are likely to benefit more from diffused technology, e.g., those that have newer patents, are more profitable, and face better growth opportunities. The spillover impact remains strong when product market competition and own-firm innovations are accounted for. Overall, our study identifies technology spillovers as an important factor in determining corporate cash policy.

Agency Conflicts and Cash: Estimates from a Dynamic Model

ABSTRACTWhich agency problems affect corporate cash policy? To answer this question, we estimate a dynamic model of finance and investment with three mechanisms that misalign managerial and shareholder incentives: limited managerial ownership of the firm, compensation based on firm size, and managerial perquisite consumption. We find that perquisite consumption critically impacts cash policy. Size‐based compensation also matters, but less. Firms with lower blockholder and institutional ownership have higher managerial perquisite consumption, low managerial ownership is a key factor in the secular upward trend in cash holdings, and agency plays little role in small firms' substantial cash holdings.

Financial Flexibility and Corporate Cash Policy

Using variations in local real estate prices as exogenous shocks to corporate financing capacity, we investigate the causal effects of financial flexibility on cash policies of US firms. Building on this natural experiment, we find strong evidence that increases in real estate values lead to smaller corporate cash reserves, declines in the marginal value of cash holdings, and lower cash flow sensitivities of cash. The representative US firm holds $0.037 less of cash for each $1 of collateral, quantifying the sensitivity of cash holdings to collateral value. We further find that the decrease in cash holdings is more pronounced in firms with greater investment opportunities, financial constraints, better corporate governance, and lower local real estate price volatility.

Determinants of corporate cash policy: Insights from private firms

We provide one of the first large sample comparisons of cash policies in public and private U.S. firms. We first show that despite higher financing frictions, private firms hold, on average, about half as much cash as public firms do. By examining the drivers of cash policies for each group, we are able to attribute the difference to the much higher agency costs in public firms. By combining evidence from across public and private firms as well as within public firms across different qualities of governance, we are able to reconcile existing mixed evidence on the effects of agency problems on cash policies. Specifically, agency problems affect not only the target level of cash, but also how managers react to cash in excess of the target.

Do CEO demographics explain cash holdings in SMEs?

Summary This study examines the idiosyncratic manager-specific influence on corporate cash holdings. Although traditional economic theories such as trade-off theory, financial hierarchy theory and agency free cash flow theory have already contributed to a deeper understanding of corporate cash policy, we examine whether the integration of the Upper Echelons Theory (UET) into these traditional theories provides additional power in explaining corporate cash holdings. We contend that social, psychological and cognitive characteristics of CEOs, proxied by a number of CEO demographics, affect the level of importance that CEOs (and shareholders) attach to the economic arguments provided by the traditional theories, in turn affecting cash policy. We test our hypotheses using a sample of Belgian privately held SMEs. Controlling for the impact of traditional economic theories our findings suggest that older CEOs and CEOs without experience in other industries are more concerned with the precautionary motive of cash and less concerned with the opportunity cost of cash, giving rise to higher cash levels compared to younger CEOs and CEOs with other-industry experience. This indicates that cash policy in Belgian privately held SMEs reflects the natural tendencies of CEOs. Since cash policy affects shareholder value, it is important for stakeholders to consider the demographics of present or new CEOs and to understand their associated inclinations concerning cash policy.

Corporate Fraud, External Debt and Corporate Cash Policy

This paper explores the financial implications of corporate fraud by examining the impacts of corporate fraud on fraudulent firms’ external financing cost and internal cash holdings. Using a sample consist of 184 fraudulent firms that experience material litigation in securities class action, we find that firms’ cost of debt significantly increases associated with corporate fraud incident. In response to the costly external finance, fraudulent firms retain more cash to better cope with adverse shocks. Consistent with the precautionary motive argument, the value of cash increases after corporate fraud. In addition, corporate fraud contributes to financial constraints in the sense that fraudulent firms display a positive cash flow sensitivity of cash after corporate fraud. Our result indicates that corporate fraud can have a real impact on corporate outcomes by affecting the external financing cost and internal cash holdings.

Technology Spillovers, Product Market Rivalry and Financial Flexibility

This study examines the effect of technology spillovers on firms’ cash holdings. It finds that firms facing greater technology spillovers hold higher cash balances. This effect is more pronounced among financially constrained firms and for firms that are likely to benefit more from diffused technology, e.g., those have newer patents, are more profitable, and face better growth opportunities. The spillover impact remains strong when product market competition and own-firm innovations are accounted for. Overall, our study identifies technology spillovers as an important factor in determining corporate cash policy.

Determinants of Corporate Cash Policy: Insights from Private Firms

We provide one of the first large sample comparisons of cash policies in public and private U.S. firms. We first show that despite higher financing frictions, private firms hold, on average, about half as much cash as public firms do. By examining the drivers of cash policies for each group, we are able to attribute the difference to the much higher agency costs in public firms. By combining evidence from across public and private firms as well as within public firms across different qualities of governance, we are able to reconcile existing mixed evidence on the effects of agency problems on cash policies. Specifically, agency problems affect not only the target level of cash, but also how managers react to cash in excess of the target.

Cross-country analysis of secular cash trends

This study documents a pronounced secular upward trend in cash holdings which is almost systemic across seven industrialized countries over 1991–2008, with France exhibiting a modest rise and Japan a substantial decline. However, the driving forces underlying the cash pattern are not uniform across countries. While the evolution in firm characteristics necessitated elevated cash balances, the time-varying firm attributes explain the cash trend only in Canada, France, UK and the US. The agency motive plays a role in the rise in cash balances in Germany. Our analysis highlights that the functioning of the financial system is crucial to corporate cash policy as Australia’s cash pattern is driven by shallow private credit markets that curbed cash reserves earlier on and the decelerating cash trend in Japan is ascribed to financial reforms. While there is a degree of commonality in the determinants of cash policies, we find some divergence in cash practices.

Determinants of Corporate Cash Policy: A Comparison of Public and Private Firms

We provide one of the first large sample comparisons of cash policies in public and private U.S. firms. We first show that on average private firms hold less than half as much cash as public firms do. The higher cash holdings of public firms are partially caused by the fact that public firms add more to their cash reserves in a given year, even controlling for a number of spending and savings factors, than do similar private firms. Further, consistent with the presence of financing frictions, we find that private firms adjust much more slowly to their target cash levels when they have a cash deficit than public firms do, and private firms’ cash-to-cash flow sensitivity is higher than that of public firms. Overall, our evidence supports both the agency conflicts and the financing frictions views of corporate cash policy.

Agency Conflicts and Cash: Estimates from a Structural Model

Which agency problems affect corporate cash policy? To answer this question, we estimate a dynamic model of finance and investment with three mechanisms that misalign managerial and shareholder incentives: limited managerial ownership of the firm, compensation based on firm size, and managerial perquisite consumption. We find that perquisite consumption critically impacts cash policy. Size-based compensation also matters, but less. Firms with lower blockholder and institutional ownership have higher managerial perquisite consumption; low managerial ownership is a key factor in the secular upward trend in cash holding; and agency plays little role in small firms' substantial cash holdings.