Liquid Asset Holdings Research Articles

Shift from gross profit taxation to distributed profit taxation: Are there effects on firms?

This paper investigates the consequences of the corporate tax reform in Estonia in 2000. This unique reform nullified the taxation of retained earnings and maintained corporate income tax only on distributed profits. We investigate the outcome of the reform by comparing the performance of the affected firms in Estonia with that of firms from Latvia and Lithuania, the two other Baltic countries. We use firm-level financial data and the difference in differences approach for our analysis. The results are consistent with an increase in holdings of liquid assets and lower use of debt financing after the reform. A positive relationship of the reform with post-reform investment and productivity has also been found. The results point to a stronger effect on smaller firms.

Changes in U.S. Household Balance Sheet Behavior after the Housing Bust and Great Recession: Evidence from Panel Data

This paper uses panel data through 2011 to examine evidence of shifts in household balance sheet behavior following the financial crisis and Great Recession. The paper considers evidence of balance sheet repair through debt repayment as well as changes in the composition of households’ balance sheets and/or saving decisions to determine whether households’ desire for holding or investing in riskier versus safer assets has changed. The data show relatively small and limited balance sheet adjustment — especially for those households considered the most likely to have been impacted by the economic collapse. The adjustment that did occur typically raised households’ liquid asset holdings and/or saving and reduced their risky asset positions (stocks). There is also some evidence of increased nonhousing debt repayment and slower takeup of new nonhousing debt. Overall, the findings are inconsistent with major adjustments occurring in households’ balance sheet behavior — especially to the extent where these shifts would have contributed substantially to the sluggish economic recovery.

Bank Capital, Liquid Reserves, and Insolvency Risk

We develop a dynamic model of banking to assess the effects of liquidity and leverage requirements on banks' insolvency risk. In this model, banks face taxation, flotation costs of securities, and default costs and maximize shareholder value by making their financing, liquid asset holdings, and default decisions in response to these frictions as well as regulatory requirements. Our analytic characterization of the bank policy choices shows that imposing solely liquidity requirements leads to lower bank losses in default at the cost of an increased likelihood of default. Combining liquidity requirements with leverage requirements reduces drastically both the likelihood of default and the magnitude of bank losses in default.

Can Changes in the Cost of Cash Resolve the Corporate Cash Puzzle?

Firms until recently were effectively constrained to hold liquid assets in non-interest-bearing accounts. As a result, the cost of capital of firms' liquid assets portfolios exceeded the return, especially when the risk-free interest rate was high. The spread between cost and return is the cost of carry. Changes in the cost of carry explain the dynamics of corporate holdings both in the United States and abroad, and the level of cost of carry explains the level of liquid asset holdings across countries. We conclude that current US corporate cash holdings are not abnormal in a historical or international comparison.

Liquidity stress-tester: do Basel III and unconventional monetary policy work?

This article presents a macro stress-testing model for liquidity risks of banks, incorporating the proposed Basel III liquidity regulation, unconventional monetary policy and credit supply effects. First and second round (feedback) effects of shocks are simulated by a Monte Carlo approach. Banks react according to the Basel III standards, endogenizing liquidity risk. The model shows how banks’ reactions interact with extended refinancing operations and asset purchases by the central bank. The results indicate that Basel III limits liquidity tail risk, in particular if it leads to a higher quality of liquid asset holdings. The flip side of increased bond holdings is that monetary policy conducted through asset purchases gets more influence on banks relative to refinancing operations.

Bank Risk, Short-Term Leverage, and the Recent Financial Crisis

This timely paper examines a fundamental cause of the recent financial crisis motivated by a specific type of funding liquidity risk also known as rollover risk. I explore short-term leverage as a function of the level of maturity mismatch through analysis of a bank’s inability to refinance short-term debt and holdings of liquid assets. This study examines the firm-level effects of various measures of rollover risk on broad market measures of risk including total risk, idiosyncratic risk, and interest rate risk for bank holding companies. Results suggest that banks can achieve economically important reductions in risk through reductions in short-term debt in the forms of sale and repurchase agreements and brokered deposits. Counterintuitive to the notion that liquid assets provide a buffer against shocks, I also find that bank risk cannot be further reduced by holding additional cash and treasury bonds. Results have important managerial and regulatory implications for the assessment of risk exposures utilizing information that is readily available and discernable from banks’ balance sheets and income statements.

Sheltering Corporate Assets from Political Extraction

We hypothesize that firms structure their asset holdings so as to shelter assets from extraction by politicians and bureaucrats. In countries where the threat of political extraction is higher, we hypothesize that firms hold a lower fraction of their assets in liquid form. Consistent with this conjecture, using data representing over 30,000 firms across 109 countries, we find that corporate holdings of liquid assets are negatively correlated with measures of political corruption. Further, annual investment in property, plant, equipment, and inventory plus dividends is positively correlated with measures of political corruption suggesting that owners channel their cash into harder to extract assets. To the extent that the threat of political extraction moves firms away from their otherwise optimal levels of liquid assets, our findings suggest that the threat of political extraction may reduce economic development not only through the direct costs of political payoffs but also because the potential for asset extraction moves firms away from their otherwise optimal asset holdings. The Author 2011. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oup.com, Oxford University Press.

Does Enhanced Disclosure Really Reduce Agency Costs? Evidence from the Diversion of Corporate Resources

ABSTRACTThis study investigates whether extensive disclosure reduces managerial expropriation of corporate resources by examining the potential effects of enhanced reporting on the values of cash assets and investment ventures, respectively. We uncover evidence that liquid asset holdings are valued at a discount by firms with fewer disclosure practices than their more transparent counterparts. Moreover, disclosure activity substantially improves the value of cash assets in excess of requirements for operations and investment. These findings suggest that detailed reporting facilitates the scrutiny and discipline of capital markets, thus preventing the diversion of cash reserves. In further support of the disciplinary power of greater disclosure, we find that value-destroying projects, through internal capital investment and external acquisitions, are concentrated in firms adopting opaque disclosure policies. Collectively, our results support the premise that extensive disclosure impairs insiders' abilities to utilize corporate resources in a self-serving manner.Data Availability: Data are available from public sources indicated in the text..

The Public Duties and Social Responsibilities of Big British Banks

The implicit social compact between the big British banks and the U.K. government broke down in the 1980s. Since then, the banks have sought to maximize shareholder value by closing less profitable branches, thereby reducing access to finance and increasing risk taking. Post-1990, the big banks also substantially increased their dependency on wholesale funding and dramatically reduced their liquid asset holdings, which increased their leverage and risk exposure. The U.K. government’s response to the financial crisis was to encourage mergers between banks, increasing concentration in the industry. The government bail-outs allowed the big banks to enjoy free insurance paid by taxpayers. The establishment of an autonomous retail banking (and insurance) utility regulator and a system for taxing the big banks fairly is recommended.

Gross Profit Taxation Versus Distributed Profit Taxation and Firm Performance: Effects of Estonia’s Corporate Income Tax Reform

Systems of profit taxation are undergoing continuous change and are subject to numerous studies. This paper estimates the effect of the corporate tax reform in Estonia in the year 2000, a reform that was unique anywhere. This reform nullified the taxation of retained earnings and retained the corporate income tax only on distributed profits. We estimate the effect of the reform on firms’ capital structure, liquidity, investments and productivity. The effect of the reform is identified by comparing the performance of Estonian firms that were affected with that of firms from Latvia and Lithuania, the two other Baltic states, which are economically fairly similar to Estonia and have correlated business cycles. We use firm-level financial data and the difference in differences and propensity score matching methods for our analysis. The results show that the corporate tax reform has resulted in increased holdings of liquid assets and lower use of debt financing; these results can be seen especially among the smaller companies affected by the liquidity constraints. These developments have contributed positively to firms’ survival during the recent global economic crisis. A positive effect on investment and labour productivity has also been found, especially among companies in the services sector. The results imply that distributed profit taxation schemes may have significant positive effects on economic development and firms’ survival.

The Determinants of Trade Credit: Evidence from Indian Manufacturing Firms

Trade credit (accounts receivable and accounts payable) is both an important source and use of funds for manufacturing firms in India. This paper empirically investigates the determinants of trade credit in the Indian context. The empirical evidence presented suggests that strong evidence exists in support of an inventory management motive for the existence of trade credit. Highly profitable firms both give and receive less trade credit. Firms with greater access to bank credit offer less trade credit to their customers. On the other hand, firms with higher bank loans receive more trade credit. Holdings of liquid assets have a positive influence on both accounts receivable and accounts payable.

Capital Structure, Firm Liquidity and Growth

This paper is an exploration of the relationships among the firm's financial structure, its choice of liquid asset holdings, and growth. We present a theoretical model of the firm where external finance is costly and where retaining earnings as liquid assets serves a precautionary motive. One of the predictions of this model is that a long-term reliance on high levels of debt finance tends to be associated with high levels of liquid asset holding. We test this empirically by estimating the determinants of liquid asset holdings using panel data sets of Belgian and UK firms. We find evidence of a positive relation between leverage and liquid asset holding. This result leads us to identify a possible linkage from high debt to high liquidity to slow growth. In light of this we discuss the possible implications of the development of stock markets, private equity, and venture capital markets.

The Liquidity Regulation and Savings Banks' Liquid Assets

The Liquidity Regulation and Savings Banks' Liquid Assets For their short-term payment obligations, savings banks hold substantially more liquid assets than the liquidity regulation requires. This paper investigates whether sight deposits, an important funding source for savings banks, help in explaining liquid asset holdings in excess of regulatory requirements. We analyze whether savings banks transform sight deposits in illiquid assets less intensively than is permitted because (i) the liquidity regulation underestimates actual withdrawal rates (underestimation effect) and/or (ii) savings banks are subject to limits in their lending to non-banks that they do not offset by, for instance, medium-term interbank lending or fixed asset holdings (lending effect). In our sample, we do not find the underestimation effect to be applicable as actual deposit withdrawal rates are in most cases lower than the regulatorily specified rate. However, we find the lending effect to be at work: Savings banks with low shares of loans to non-banks do not transform sight deposits into illiquid assets as intensively as savings banks with high shares of non-bank loans. Our analysis does not only show that liquid assets positively depend on sight deposits, but also shines a light on how bank size and the individual bank's position in the interbank market affect liquid assets. (JEL G21) Die Liquiditätsregulierung und liquide Aktiva von Sparkassen Sparkassen verfügen über wesentlich mehr innerhalb des nächsten Monats verfügbare Zahlungsmittel, als sie gemäß Liquiditätsverordnung für ihre in diesem Zeitraum abrufbaren Zahlungsverpflichtungen halten müssen. Die vorliegende Arbeit untersucht, ob Sichteinlagen, die eine wesentliche Finanzierungsquelle für Sparkassen darstellen, zu dem hohen Bestand an Zahlungsmitteln beitragen, weil (i) die regulatorisch spezifizierte Marke der Einlagenabzüge die tatsächlichen Abzüge unterschätzt (Unterschätzungseffekt) und/oder (ii) Sparkassen Grenzen bei der Kreditvergabe an Nicht-Banken ausgesetzt sind, die sie nicht durch Investitionen in andere illiquide Aktiva (z. B. mittelfristige Interbankkredite) kompensieren (Krediteffekt). Wir finden keine Evidenz für einen Unterschätzungseffekt: Der Vergleich der tatsächlichen Einlagenabzüge mit der regulatorisch spezifizierten Marke von 10% deutet an, dass die regulatorische Marke in dem von uns verwendeten Datensatz als konservativ zu bezeichnen ist. Wir finden jedoch Hinweise auf das Wirken eines Krediteffekts: Sparkassen mit wenigen Krediten an Nicht-Banken transformieren Sichteinlagen weniger intensiv in illiquide Aktiva als Sparkassen mit vielen Nicht-Bankkrediten. Unsere Untersuchung zeigt nicht nur, dass die Zahlungsmittel positiv von den Sichteinlagen abhängen, sondern gibt auch Anhaltspunkte, wie bankspezifische Faktoren das Halten von Zahlungsmitteln beeinflussen.

Crisis Resolution and Bank Liquidity

What is the effect of financial crises and their resolution on banks' choice of liquidity? When banks have relative expertise in employing risky assets, the market for these assets clears only at fire-sale prices following a large number of bank failures. The gains from acquiring assets at fire-sale prices make it attractive for banks to hold liquid assets. The resulting choice of bank liquidity is countercyclical, inefficiently low during economic booms but excessively high during crises. We present evidence consistent with these predictions. While interventions to resolve banking crises may be desirable ex post, they affect bank liquidity in subtle ways: Liquidity support to failed banks or unconditional support to surviving banks reduces incentives to hold liquidity, whereas support to surviving banks conditional on their liquid asset holdings has the opposite effect. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Bank liquidity providing in a real synergy management under a cap-based valuation

Since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. We explore this function under a cap-based valuation. We find that (i) the strike price of the cap-based valuation increases the bank's liquid asset holdings by increasing its loan rate and loan commitment rate (with the strategic rate-adjustment complements) and decreases the bank's external finance need by increasing its deposit rate, when the bank realizes a less risky state of the world and (ii) the number of caplet days decreases the bank's liquid asset holdings by decreasing its loan rate and loan commitment rate (with the strategic rate-adjustment complements and the strategic timing substitutes) and increases the bank's external finance need by decreasing its deposit rate (with the strategic timing substitutes), when the bank realizes a more risky state. Our findings provide alternative explanations concerning the bank's liquidity function under the cap-based optimization.

Liquidity Stress-Tester: Do Basel III and Unconventional Monetary Policy Work?

This paper presents a macro stress-testing model for liquidity risks of banks, incorporating the proposed Basel III liquidity regulation, unconventional monetary policy and credit supply effects. First and second round (feedback) effects of shocks are simulated by a Monte Carlo approach. Banks react according to the Basel III standards, endogenising liquidity risk. The model shows how banks’ reactions interact with extended refinancing operations and asset purchases by the central bank. The results indicate that Basel III limits liquidity tail risk, in particular if it leads to a higher quality of liquid asset holdings. The flip side of increased bond holdings is that monetary policy conducted through asset purchases gets more influence on banks relative to refinancing operations.

Endogenous Choice of Bank Liquidity: The Role of Fire Sales

Banks’ liquidity is a crucial determinant of the adversity of banking crises. In this paper, we consider the effect of fire sales and entry during crises on banks’ ex-ante choice of liquid asset holdings. We consider a setting with limited pledgeability of risky cash flows relative to safe ones and a differential expertise between banks and outsiders in employing banking assets. When a large number of banks fail, market for assets clears only at fire-sale prices and outsiders enter the market if prices fall sufficiently low. In such states, there is a private benefit of liquid holdings to banks from purchasing assets. There is also a social benefit since greater banking system liquidity reduces inefficiency from liquidation of assets to outsiders. When pledgeability of risky cash flows is high, for instance, in countries with well-developed capital markets, banks hold less liquidity than is socially optimal due to risk-shifting incentives; otherwise, banks may hold even more liquidity than is socially optimal to capitalise on fire sales. However, if there is a systemic cost associated with crises, for example, in the form of fiscal costs associated with provision of deposit insurance, then socially optimal liquidity may always be higher than the privately optimal one, and, in turn, regulation in the form of prudent liquidity requirements may be desirable. We provide some international evidence on banks’ liquid holdings that is consistent with model’s predictions.

Liquidity, Investment and Risky Debt: Some Evidence

Utilizing bond data for U.S. non-financial corporations, this study finds a relationship between liquid assets and default premia. The paper argues that this can be explained by endogenous adjustments in liquid asset holdings by firms concerned with the possibility of a liquidity shortage, which, in the presence of external financing constraints, may trigger default and the costs of financial distress. As a result, riskier firms have not only higher default premia, but also larger holdings of liquid assets. Thus, the endogeneity of liquidity may be central to the interaction between default risk and the condition of the firm’s balance sheet. Simple regressions that treat liquidity as an exogenous parameter may therefore yield unreliable results. In our model, a positive relationship arises when future firm cash flows cannot be fully pledged as collateral for borrowing and the benefits of firm investment can only be realized if the firm does not default. At the same time, exogenous changes in the firm’s liquidity are expected to be negatively related to default premia. The prior expectation that firms with high liquidity should be safer explains the direct effect of liquidity on default premia, but does not capture the indirect effect arising from the endogeneity of liquidity, which appears to dominate in practice. Previous studies have focused on leverage and volatility as determinants of default premia, and ignore the potential effect of liquidity. Others assume that default is triggered by a shortage of cash, but they do not allow for an endogenous determination of liquidity. The results obtained here suggest that firm characteristics that determine default premia, such as leverage, volatility, profitability and financing constraints, may also affect the firm’s liquidity, which, in turn, affects default spreads. Our results also suggest that common empirical specifications in studies of default premia, which use default risk variables suggested by extant models, may be overlooking important variables. Int Adv Econ Res (2009) 15:492–493 DOI 10.1007/s11294-009-9221-z

Corporate cash holdings, uncertainty avoidance, and the multinationality of firms

We examine the relationship between uncertainty avoidance, multinationality and firm cash holdings. We develop several hypotheses from corporate finance and multinational firm theory, positing that cultural factors as well firm multinationality influence corporate cash holdings. In particular, firms in countries with high uncertainty avoidance hold more cash as a way to hedge against undesired states of nature. At the same time, firm multinationality moderates the effects culture has on the firm's holdings of liquid assets. Based on a large panel of firms in fifty countries, we present evidence consistent with these hypotheses. Firms in countries with high levels of uncertainty avoidance tend to hold more cash. Against commonly held views in cash management, the degree of multinationality of the firm is positively correlated with holdings of cash. At the same time, the effect of national culture on firm's cash holdings is lower for multinationals. These results are economically significant.

Securitization and the Declining Impact of Bank Finance on Loan Supply: Evidence from Mortgage Originations

ABSTRACTLow‐cost deposits and increased balance sheet liquidity raise banks' supply of illiquid loans more than loans easily sold or securitized. We exploit the inability of Fannie Mae and Freddie Mac to purchase jumbo mortgages to identify an exogenous change in liquidity. The volume of jumbo mortgage originations relative to nonjumbo originations increases with bank holdings of liquid assets and decreases with bank deposit costs. This result suggests that the increasing depth of the mortgage secondary market fostered by securitization has reduced the effect of lender's financial condition on credit supply.