While prior studies show that firms save more cash under precautionary motive during the crisis period, we argue that firms also consume cash for their investment projects and/ or operat
Introduction
Research Background
An increase in cash reserves can significantly aid companies in restoring operational effectiveness during a recession triggered by a financial crisis Cash and cash equivalents, which are highly liquid financial assets, hold the highest level of liquidity among a corporation's assets Keynes (1936) suggests that the maintenance of cash holdings is driven by transactional, preventive, and speculative motivations, especially during economic downturns Subramaniam et al (2011) emphasize the importance of cash and cash equivalents on a firm's balance sheet, as they attract considerable interest from companies, investors, and analysts This significance is particularly pronounced in times of depression, as highlighted by the findings of Duchin et al.
Since 2010, financing costs have surged during financial crises, severely affecting businesses Companies with limited cash reserves faced the greatest challenges, as new investments dwindled significantly Historical financial crises, such as the 1997 Asian Financial Crisis, the 2007 US Subprime Crisis, and the 2008 Global Financial Crisis, have profoundly influenced the global economy.
2009 European Debt Crisis, and the 2011 US Debt Crisis (Nguyen, Castro, & Wood,
The Covid-19 health crisis and other recent events have severely affected investor confidence in financial markets, leading financial professionals to emphasize the critical importance of currency Cash is essential for various corporate financial activities, including financing, investments, and overall performance, as highlighted by Chen et al (2020) De Vito and Gomez (2020) note that companies with limited operational flexibility may exhaust their cash reserves within two years due to the pandemic, significantly compromising their liquidity However, there is a notable lack of empirical evidence on how substantial capital reserves can help companies quickly restore operational performance during crises This study aims to address this gap.
Research has extensively explored the various aspects of cash holdings, revealing that strategic factors significantly influence cash holding strategies (Fresard, 2010) Companies with larger cash reserves can capture a greater market share compared to their competitors and enhance operational efficiency within the industry Current studies primarily investigate the determinants of cash holdings, examining how factors such as investment opportunities (Bates, Kahle, & Stulz, 2009; Tran, 2020), financing constraints (Riddiough & Wu, 2009; Sasaki & Suzuki, 2019), and corporate governance (Harford, Mansi, & Maxwell) impact firms' cash reserves.
Research indicates that factors such as corporate governance and policy uncertainty significantly impact firms' cash holdings Various studies have explored how cash holdings affect critical corporate financial decisions, including investment choices, firm performance, and financing strategies.
Modigliani and Miller's 1958 theory posits that in perfect capital markets, the costs of internal and external funding are equal, allowing firms to separate their investment and financing decisions However, real-world market frictions create obstacles that increase the costs of external funding Jensen (1986) highlights that companies with substantial cash reserves incur high agency costs and inefficiencies in managing liquid assets Despite this, Ozkan and Ozkan (2004) note that firms hold cash primarily for precautionary reasons and to avoid transaction costs Bates et al (2009) argue that corporate cash reserves are essential for seizing profitable investment opportunities and addressing unexpected challenges This indicates that firms prefer to retain cash to sidestep costly external funding methods, as suggested by Myers and Majluf (1984) Conversely, companies lacking sufficient capital are more likely to reject attractive investment opportunities and struggle to maintain operations (Campello, Graham, & Harvey, 2010; Ivashina & Scharfstein, 2010).
Corporate liquidity management has become increasingly important due to the constraints on external funding imposed by the global financial crisis During such crises, the cautious motive for holding cash intensifies, as companies face inefficiencies in capital markets and limited bank credit, leading them to accumulate higher cash reserves as a precaution Research indicates that financial crises positively affect cash flow sensitivity and cash holdings However, cash reserves are influenced not only by savings but also by expenditures, as companies tend to rely more on existing cash for investments when access to credit diminishes This reliance aligns with the pecking order theory, suggesting that a crisis may ultimately reduce corporate cash reserves if expenditures exceed cash flow conservation This article investigates the global crisis's impact on cash savings and allocations using data from over 100 countries.
Numerous studies highlight the importance of cash holdings during economic downturns and financial crises, revealing that effective cash management policies are vital in navigating these challenging times.
Numerous studies indicate that companies often overlook the importance of maintaining an optimal cash balance as a safeguard against economic downturns (Ang & Smedema, 2011) Research by Chen et al (2018) reveals that firms with higher pre-accumulated cash levels are more likely to increase capital investments during significant economic downturns This suggests that substantial cash reserves enable businesses to mitigate underinvestment issues during financial crises Ahrends et al (2018) further demonstrate that corporate cash holdings empower firms to seize expansion opportunities in challenging times However, there is limited research on how cash reserves affect a company's recovery speed during financial crises Overall, it can be concluded that firms with ample cash reserves can make strategic investments that enhance growth momentum, allowing them to quickly recover and improve operational performance after a crisis.
This study aims to investigate whether companies with high cash reserves can quickly recover their operational performance during financial crises The analysis is based on the definitions and crisis periods established by Reinhart and Rogoff (2011), focusing on specific years of economic turmoil.
1990 to 2010 The samples consist of firms located in countries that have experienced currency crises, crises of banking, sovereign external debt crises, and domestic debt crises.
Research Objective
This study examines the effects of the pandemic outbreak on corporate cash holdings from 2005 to 2022, a period that encompasses various crises and fluctuations in cash management strategies.
Research Contribution to Knowledge
There is a lack of empirical data regarding the fluctuations in corporate cash holdings during crises and non-crisis periods Additionally, this study does not categorize crises into specific types, instead encompassing all crises encountered by firms.
From 2005 to 2022, various firms experienced multiple crises, with some facing two or three simultaneously This paper conducts extensive research based on established theories to provide current insights into cash holdings during crisis periods It offers a comprehensive analysis of cash holdings and firm performance, utilizing recent data from 2005 to 2022 Our findings challenge Opler's conclusion by revealing a more complex relationship between cash flows and corporate cash holdings during crises This study significantly contributes to existing literature by presenting substantial evidence on how cash holdings ratios fluctuate during crises and how these changes may be moderated across broader observations and timeframes.
Overview of Dissertation
This article is organized into several key sections: Section 2 presents a literature review and formulates hypotheses, while Section 3 explores the empirical findings of the study Section 4 engages in a discussion, addressing the endogenous issue, followed by Section 5, which offers additional analysis Finally, Section 6 concludes with recommendations.
Literature Review & Hypothesis Development
Corporate Cash Holdings
The scholarly literature on corporate cash holdings explores various aspects, including the reasons for maintaining cash reserves, the optimal level of these reserves, and influencing factors Core concepts such as Trade-off Theory and Pecking Order Theory provide valuable insights into corporate cash management Trade-off Theory emphasizes achieving an optimal balance between the marginal benefits and costs of holding cash, while Pecking Order Theory highlights a preference for internal funding over external sources Together, these theories elucidate the motivations behind corporate cash holdings.
Determining if a corporation holds an excessive amount of cash in relation to maximizing shareholder wealth involves analyzing the tradeoffs between the advantages and disadvantages of cash reserves Different motivations for cash holdings lead management and shareholders to assess the costs and benefits of liquid assets variably Agency theory elucidates why corporations may not maintain the optimal cash levels for shareholder wealth and highlights those likely to retain excess cash The potential of cash to mitigate business risks and enhance managerial decision-making creates a preference for liquidity among managers As noted by Amess, Banerji, and Lampousis (2015), this increased demand for cash may result in managers overvaluing the necessity of maintaining cash reserves Consequently, firms with higher managerial discretion costs should maintain greater liquidity than necessary to optimize shareholder value.
Cash levels in firms are influenced by specific characteristics such as size, industry standards, and governance practices Additionally, macroeconomic conditions play a crucial role in determining cash holdings, as companies often accumulate cash as a risk management strategy during economic downturns Recent trends highlight how businesses are adapting their cash management strategies in response to global economic challenges.
In this section, we explore the crucial role of transaction expenses in shaping total cash reserves We then shift our focus to the effects of knowledge asymmetries and agency costs on cash holdings Finally, we conclude with an analysis of the funding hierarchy model, highlighting its significance in understanding cash management.
Transaction Cost Model
The Transaction Cost Theory, introduced by Ronald Coase in 1937 and further developed by Oliver Williamson in 1979 and 1981, serves as a crucial framework for understanding corporate cash holdings This theory posits that firms aim to minimize costs related to external financing and asset liquidation, making the maintenance of cash reserves a sensible strategy Research by Bates, Kahle, and Stulz supports this perspective.
A 2009 study explores the rising trend in cash holdings, attributing this increase to the consistently high transaction costs of acquiring external funds, making cash a more economical option for businesses.
The 2008 financial crisis highlighted the transaction cost model's relevance during crises, revealing how such events intensify knowledge asymmetry between businesses and investors, thereby increasing transaction costs (Jensen & Meckling, 1976) Harford, Klasa, and Maxwell (2014) investigated how companies with significant cash reserves navigated economic downturns, successfully seizing investment opportunities while less financially agile competitors struggled with liquidity issues Their findings support the precautionary motive for cash retention, a key element influencing corporate liquidity decisions (Almeida, Campello, & Weisbach, 2004).
Contrary to the belief that higher cash reserves are beneficial during crises, Acharya, Almeida, and Campello (2013) argue that companies often deplete these funds to meet urgent financial obligations, such as debt payments, which can jeopardize future growth Their study reveals a dual nature of cash holdings in crises, acting as both a protective buffer and a potential barrier to long-term prospects due to immediate financial demands.
Denis and Sibilkov (2010) explored the impact of company governance on cash holdings during crises, revealing that firms with stronger governance structures are better at utilizing their cash reserves This indicates that effective managerial practices play a crucial role in reducing transaction costs, highlighting that liquidity alone does not determine a company's financial efficiency.
Current research highlights the importance of industry-specific cash retention patterns, particularly in sectors with unstable cash flows like technology and pharmaceuticals A study by Opler et al (1999) found that these industries tend to maintain larger cash reserves to reduce transaction costs Additionally, Foley et al (2007) noted differing cash holding behaviors across sectors during the Asian Financial Crisis, underscoring the significance of sectoral insights during economic downturns.
Transaction Cost Theory serves as a crucial framework for understanding the importance of cash holdings in corporations, particularly during crises when their role becomes more pronounced yet complex Maintaining cash reserves can provide strategic advantages and enhance financial stability, but it may also lead to challenges if companies must liquidate assets to meet immediate needs Additionally, the interplay between governance structures and industry contexts adds further complexity, highlighting the need for continued academic investigation in this area.
Capital structure theories
Capital structure theories, as outlined by Weidemann (2018), focus not just on a company's cash-holding strategy but also on a comprehensive analysis of various financing methods for its operations These theories address the challenges associated with agency The trade-off theory considers additional factors beyond agency challenges, while the pecking-order theory addresses distinct agency-related issues not covered by the trade-off perspective.
The Trade-Off Theory, introduced by Kraus and Litzenberger (1973), is a key framework for understanding corporate cash accumulation, suggesting that companies strive for an optimal cash reserve by balancing the benefits of liquidity against the opportunity costs of forgoing investment opportunities Holding cash is crucial for maintaining financial stability and protecting against unforeseen challenges, yet it can hinder potential growth Empirical studies, including Myers (1984), support this theory by showing that firms prefer to retain a specific level of cash to mitigate the negative effects of financial distress and the costs associated with obtaining external financing.
During economic crises, the relationship between the Trade-Off Theory and corporate cash holdings becomes more complex Almeida et al (2014) argue that companies increase cash reserves to address liquidity concerns during downturns, aligning with the cautious motives of the Trade-Off Theory Research following the 2008 financial crisis, such as that by Foley et al (2007), found that firms with significant cash reserves demonstrated enhanced resilience to unexpected shocks, allowing them to better manage economic challenges This highlights the importance of precautionary motives in protecting companies from adverse situations.
Recent literature reveals conflicting evidence regarding the benefits of cash holdings during crises Acharya, Almeida, and Campello (2013) argue that these advantages may not be applicable in such scenarios, particularly for companies with poor corporate governance During crises, these firms may misallocate cash reserves, leading to financial difficulties and challenging the core tenets of the Trade-Off Theory.
Sector-specific nuances play a crucial role during crises, as highlighted by Palazzo's (2012) research Companies in volatile industries like technology and pharmaceuticals often deviate from their optimal cash reserves during such times, either exceeding or lacking their targeted cash holdings This suggests that the traditional Trade-Off Theory may not fully capture the complexities of managing cash reserves in crisis situations.
The research by Nikolov and Whited (2014) explores how macroeconomic conditions affect enterprise decision-making about cash reserves It highlights that during crises, macroeconomic indicators like inflation and GDP growth significantly influence the cost-benefit analysis of businesses, ultimately shaping their optimal cash reserve strategies.
The Trade-Off Theory offers a crucial framework for understanding corporate cash reserves, but its implications become more complex during crises Maintaining adequate cash reserves is generally seen as beneficial for risk management; however, factors like corporate governance and macroeconomic conditions can limit its effectiveness This dynamic landscape invites further academic exploration, especially regarding how different environments influence the trade-offs companies make concerning their cash reserves.
The Pecking Order Theory, introduced by Donaldson in 1961 and refined by Myers and Majluf in 1984, posits that organizations prefer internal financing over external sources like debt or equity when making financial decisions This theory is essential for understanding the reasons behind corporate cash reserves, as firms hold cash internally to reduce information asymmetry and the external transaction costs associated with acquiring outside capital, as demonstrated by Shyam-Sunder and Myers in 1999.
During crises, the Pecking Order Theory becomes increasingly relevant, as highlighted by Pinkowitz, Stulz, and Williamson (2016), who note that companies tend to accumulate cash reserves as a precautionary measure in volatile times This accumulation is driven by the growing information gap between managers and external investors, intensifying the need for internal financing, particularly cash Bates, Kahle, and Stulz (2009) observed a significant increase in cash reserves among firms post-dot-com bubble, indicating a preference for internal financing that aligns with Pecking Order Theory However, Almeida, Campello, and Weisbach (2004) argue that the theory may not universally apply during crises, especially for financially constrained organizations that struggle to build cash reserves and may resort to external financing despite its costs This deviation challenges the foundational premise of the Pecking Order Theory, which suggests a consistent preference for internal funding.
Faulkender and Wang (2006) highlight concerns regarding the universal applicability of the Pecking Order Theory across different types of firms They note that the theory's relevance is influenced by factors such as company size and age, especially during crises Smaller or newly established businesses often lack significant cash reserves, leading them to rely more on external financing than traditional theoretical models suggest.
The Pecking Order Theory serves as a vital framework for understanding organizational cash holdings, yet its application during crises reveals complexities Typically, firms follow this theory by building cash reserves during market instability as a precaution However, its predictive power wanes for financially constrained or smaller companies, which may need to seek external funding, contradicting the theory's core principles Therefore, while the Pecking Order Theory provides important insights into corporate cash management, its relevance is nuanced and depends on various factors, especially during financial crises.
Information asymmetric
Information asymmetry, a concept highlighted in Akerlof's "The Market for 'Lemons'" (1970), is vital in corporate finance, particularly in understanding corporate cash reserves In a perfect information environment, companies wouldn't need to hold excessive cash However, due to the information gap between management and investors, firms often retain surplus cash to mitigate adverse selection and moral hazard risks, as discussed by Myers and Majluf (1984) Research by Opler et al (1999) indicates that companies facing higher information asymmetry tend to keep larger cash reserves to protect against negative market reactions and difficulties in securing external financing This aligns with the Pecking Order Theory, which suggests that firms prefer using internal financing sources, like cash reserves, over external options The impact of information asymmetry on corporate cash holdings becomes particularly critical during crises, as noted by Harford, Klasa, and Maxwell.
The 2008 financial crisis heightened information asymmetry, prompting companies to increase cash hoarding as a protective strategy This situation made it challenging for external investors to differentiate between high-quality and low-quality firms, intensifying the market's reluctance to provide external funding Consequently, firms facing greater information asymmetry are more inclined to retain cash reserves to navigate these uncertainties (Acharya, Almedida, & Campello, 2013) However, some research, such as that by Han and Qiu, reveals deviations from these general trends.
A study conducted in 2007 found that smaller enterprises, often facing higher levels of information asymmetry, struggled to significantly increase their cash reserves during crises This indicates that while businesses may aim to build cash reserves to mitigate the effects of information asymmetry, certain characteristics of the firms can impede this goal, complicating the relationship between corporate cash holdings and information asymmetry in challenging times.
In summary, the literature reveals that knowledge asymmetry significantly impacts corporate cash holdings, with firms facing higher information asymmetry tending to retain larger cash reserves to reduce the costs of obtaining external capital This trend becomes more pronounced during crises, though variations may occur based on business size and other factors Financial turmoil intensifies the challenges associated with asymmetric knowledge, highlighting the critical role of cash as a strategic asset for companies.
Agency cost theory
The investigation of corporate cash reserves is closely linked to agency expenses, as highlighted by the agency cost hypothesis, which suggests inefficiencies arise when management and shareholder goals conflict For instance, management may retain less cash than optimal for the company's needs This theory, rooted in the foundational work of Jensen and Meckling (1976), indicates that managers with significant financial reserves might pursue self-serving initiatives that do not enhance shareholder value Research by Dittmar, Mahrt-Smith, and Servaes (2003) supports the notion that companies offering greater shareholder protections tend to maintain lower cash reserves, implying that reduced agency costs can lead to more efficient cash management.
During economic downturns, the costs of maintaining cash reserves increase significantly, leading companies to either excessively hoard cash or poorly manage their reserves, negatively impacting shareholder value Research by Gao, Harford, and Li (2013) indicates that both practices can harm a company's stock value Furthermore, Harford, Mansi, and Maxwell (2008) found that firms with inadequate governance tend to accumulate more cash reserves during crises, as managers exploit volatile conditions to secure greater discretionary funds This behavior often leads to increased agency costs, which can obscure the company's legitimate reasons for holding financial reserves (Acharya, Almedida, & Campello, 2013).
Research by Faulkender and Wang (2006) suggests that crises can unite shareholders and managers by enforcing discipline in a volatile financial climate Their study found that financial constraints during a crisis lead to reduced agency expenses, as organizations must demonstrate fiscal restraint to secure external funding This highlights the potential of crises to compel more efficient management of cash reserves and reduced agency costs.
In conclusion, agency cost theory provides valuable insights into business cash holding practices, particularly during emergencies The academic community continues to debate its implications, as the analysis of agency costs related to cash holdings has grown increasingly complex due to economic unpredictability Consequently, a more thorough empirical investigation is necessary to identify and differentiate the various factors influencing this phenomenon.
Crisis Impact on Corporate Cash Holdings (CCH)
The influence of crises on corporate cash reserves has garnered considerable academic attention, especially following the 2008 financial crisis Research by Almeida et al (2004) indicates that companies tend to increase their cash holdings as a safeguard against potential financial limitations.
Research indicates that firms have significantly increased their cash reserves over the years, primarily due to rising volatility During economic crises, companies tend to accumulate more cash to protect themselves against credit constraints and meet investment needs This behavior is particularly pronounced among larger firms, which have a wider array of investment opportunities available to them.
The academic literature on corporate cash holdings during crises has evolved from basic models to more intricate analyses, highlighting the importance of understanding financial strategies in challenging times, as demonstrated by the foundational research of Miller and Modigliani.
In 1958, it was suggested that in perfect capital markets, a firm's cash holdings are irrelevant to its overall value However, significant financial crises, including the 2000 dot-com bubble and the 2008 global financial meltdown, have intensified the scholarly debate on the importance of cash reserves in corporate finance.
In the early 2000s, Almeida et al (2004) established the precautionary motive for corporate cash holdings, suggesting that firms maintain cash reserves to protect against potential financial distress This theory gained further support from Bates et al (2009), who found a correlation between increased cash holdings and heightened earnings volatility and investment opportunities The 2008 financial crisis underscored the importance of these concepts, as highlighted by subsequent research, including that of Acharya et al.
(2013) demonstrating that firms indeed hoard cash as a safeguard against credit constraints during such periods
Recent literature has challenged the universal applicability of established theories regarding firm behavior during crises Duchin (2010) introduced the concept of firm heterogeneity, suggesting that the influence of a crisis on cash holdings varies based on specific firm characteristics, such as size and industry sector For instance, firms in consumer-sensitive sectors exhibited different responses to crises compared to those in more stable markets.
Harford et al (2014) highlighted that excessive cash holdings can be counterproductive, resulting in overinvestment and diminishing returns, which challenges the traditional precautionary motive for cash reserves This insight raises critical questions about the optimal level of cash holdings, particularly in turbulent economic conditions Recent research has begun to incorporate macroeconomic factors alongside firm-specific characteristics, with Han and Qiu (2007) emphasizing the impact of operational traits on corporate cash holdings during crises This evolution in discussion reflects the complexities inherent in contemporary finance theory and practice.
The relationship between financial limitations and crises presents an opposing viewpoint, highlighting that financial crises lead banks to tighten lending rules, resulting in a decreased willingness to provide loans According to credit shock theory, companies that heavily depend on credit are more adversely affected during a crisis, while those with less reliance on credit face comparatively milder impacts (Kahle & Stulz, 2013) Enterprises that significantly relied on external financing before the crisis are typically those without financial constraints Campello et al (2010) suggest that financially limited enterprises experience a lesser impact from crises In response to stringent financial conditions, companies may use accumulated cash reserves to repay debts, reducing the risk of default Kahle and Stulz (2013) found that highly leveraged enterprises saw a 171% decrease in net debt issuance during the crisis These findings imply that organizations with greater financial flexibility benefit from maintaining higher cash reserves, as financially constrained enterprises tend to show lower levels of indebtedness.
This study investigates the impact of cash reserves before and during financial crises, highlighting that a firm's financial policy is likely to change significantly in such times The importance of maintaining cash reserves varies among organizations, depending on their financial constraints Furthermore, the relationship between the severity of a crisis and the cash held by a company is expected to be affected by the level of corporate governance.
The combined effects of cash, constraints, and crises significantly influence corporate governance compensation proxies Firms facing constraints experience a lesser impact from crises compared to those without constraints, which rely heavily on external finance and are thus more vulnerable While constrained enterprises have a reduced reliance on external funding before a crisis, leading to less severe effects, unconstrained firms are likely to use their cash reserves to pay off debts to avoid defaults Consequently, firms without financial constraints can benefit more from maintaining higher cash reserves during crises.
As a result, the impact of constraints on cash holdings on business value will be diminished (Chang, Benson, & Faff, 2017)
Companies lacking sufficient cash reserves must seek funding through currency or capital markets, leading to increased financing costs Research by Lee and Suh (2011) highlights a positive correlation between cash reserves and share buybacks in companies across Australia, Canada, France, Germany, Japan, the United Kingdom, and the United States Their findings suggest that firms utilize share repurchases to manage temporary cash flows and excess capital, thereby reducing agency conflicts Additionally, Campello et al (2010) found that financially constrained companies tend to significantly cut their dividend payouts during crises.
During times of crises, such as health and financial downturns, corporate cash holdings are significantly affected The 2007-2008 financial crisis exemplifies how exogenous disturbances can disrupt the economic framework, leading to adverse outcomes for businesses and necessitating credit extensions (Brunnermeier, 2009) Maintaining readily available cash serves as a crucial protective measure against these external shocks (Bates, Kahle, & Stulz, 2009) Firms often increase their cash reserves in response to heightened risk levels to ensure liquidity (Boileau & Moyen, 2010) Similarly, during the COVID-19 pandemic, many companies faced a rapid decline in cash reserves as their exposure to the crisis grew, compelling them to seek assistance from credit markets to manage potential financial shortfalls (Vito & Gómez, 2020) The pandemic intensified market frictions and risk premiums, making it more challenging for businesses to maintain adequate cash reserves (Haddad & David, 2020) This indicates a non-linear relationship between corporate financial reserves and their vulnerability to the impacts of the COVID-19 pandemic.
Recent research highlights the heterogeneity among firms in relation to cash holdings during economic crises Palazzo (2012) found that the impact of crises on cash reserves varies based on factors such as firm size, industry, and operational complexity Larger firms with diversified revenue streams often increase their cash holdings during crises due to better financing access and internal capital markets However, there remains a need for further investigation, particularly regarding how the effects of economic crises on cash holdings differ across geographical regions Questions arise about whether firms in emerging markets are more or less likely to hoard cash compared to those in developed markets Additionally, understanding the relationship between monetary policy changes during crises and corporate cash-holding behaviors warrants more research.
H1a: Crisis positively affects corporate cash holdings
H1b: Crisis negatively affects corporate cash holdings
Student needs to focus on this section (i.e 2.5) instead of others (2.1 -> 2.4) Also, what is the main message from this second chapter?
Chapter 3: Data, variable, and summary statistic
Data collection
Based on an extensive dataset comprising 149,929 firm-year observations derived from a diverse pool of 10,046 public and worldwide enterprises, spanning the time frame of
From 2005 to 2022, our analysis indicates that global crises positively impact cash reserves This data was sourced from the Orbis database, recognized as the leading resource for comparable data on private companies, and the Passport database, which offers global access to internationally comparable market research, alongside crisis data from Laeven & Valencia (2020).
CFTA The ratio of Cashflow to Total asset
CashTA The ratio of Cash and Cash equivalent to Total asset
ReTA The ratio of Revenue to Total asset
SDTA The ratio of Short-term debt to Total asset
Firmsize The natural logarithm of the book value of total assets
GDP Annually GDP growth rate – data collected from Passport database
Inflation Annually Inflation rate – data collected from Passport database
Time dummy Dummy variables set for 18 period, corresponding with 18 observation years Industry dummy Dummy variables set corresponding with 109 different business sectors
Notes: The table presents the definition of variables used in this study
Firm financial factors
The present study uses descriptive statistics to analyze key characteristics within our sample of corporate years, which encompasses publicly traded enterprises from the
A comprehensive analysis reveals several factors influencing cash holdings, informed by various theories and scientific literature The tradeoff theory suggests a negative correlation between cash holdings and cash flow, indicating that businesses with higher operational cash flow tend to maintain lower cash reserves Conversely, the pecking order hypothesis asserts a positive relationship between cash reserves and cash flow size, positing that organizations with greater cash flows are more inclined to retain larger cash amounts for investment opportunities and as a buffer during financial instability Empirical studies have yielded mixed results regarding the impact of cash flow on cash holdings, with some research indicating positive effects (Opler, Pinkowitz, Stulz, & Williamson, 1999; Duchin, Ozbas, & Sensoy, 2010) while others report negative effects (Chen, Chou, & Lu, 2018).
2010), and negative (Chen, Chou, & Lu, 2018)
Organizations with higher revenue generally maintain larger cash reserves due to increased cash inflows This greater income allows companies to sustain or grow their cash reserves, enabling them to invest in capital expenditures, research and development, acquisitions, or to protect against economic downturns.
High revenue does not always lead to increased cash reserves, as companies may face higher operational expenses or choose to reinvest profits, pay dividends, or reduce debt instead of accumulating cash For instance, a company with strong earnings but low profit margins may struggle to build cash reserves, especially when burdened with substantial fixed or variable costs.
Research by Opler, Pinkowitz, Stulz, and Williamson (1999) highlights that factors influencing corporate cash holdings include profitability levels Firms with higher revenues generally maintain lower cash reserves, likely due to their improved access to external financing and a diminished need for precautionary cash.
Companies often choose to keep higher cash reserves as a precautionary measure when they have significant short-term debt This strategy acts as a financial safeguard, allowing them to meet their obligations without depending on external funding sources By holding cash, businesses can promptly settle their debts, avoiding the costs and uncertainties associated with rolling over or refinancing.
Having substantial cash reserves can lessen a company's reliance on short-term debt for immediate liquidity needs, allowing them to use internal resources However, in situations where short-term debt interest rates are low, companies might see a strategic benefit in reducing cash holdings As a result, they may choose to incur debt to meet their financial obligations rather than tapping into their cash reserves.
Research on enterprise resource allocation between cash holdings and debt acquisition highlights key factors influencing decision-making Studies by Faulkender and Wang (2006) emphasize the impact of external financing costs and agency problems on this process Additionally, Opler et al (1999) found that companies with higher cash reserves tend to maintain lower levels of both short-term and long-term debt, indicating a substitution effect between cash holdings and debt.
The trade-off theory suggests that larger organizations tend to exhibit stability, increased profitability, and diversification, leading to consistent monetary inflows and a low likelihood of insolvency This stability allows large corporations to maintain lower cash reserves, indicating a negative correlation between a company's cash holdings and its size Conversely, the pecking order hypothesis highlights disparities in financial resource allocation between large and small firms Research by Opler et al (1999) indicates a positive correlation between corporate size and cash holdings; however, existing literature presents mixed findings Some studies report negative effects of firm size on cash holdings (Shabbir et al., 2016; Opler et al., 1999; Ferreira & Vilela, 2004), while others identify positive benefits (Kariuki et al., 2015; Shabbir et al., 2016).
Macroeconomic factors
The literature review reveals a significant gap in research linking macroeconomic conditions to cash holdings (CCH) Researchers have utilized a composite measure of the conditional variation of macroeconomic variables, finding that macroeconomic uncertainty can affect cash holdings either negatively or positively, depending on the specific data and timeframe analyzed (Baum, Caglayan, & Ozkan, 2003; Baum C., Caglayan, Ozkan, & Talavera, 2004) Previous studies indicate that various macroeconomic factors, such as interest rates, inflation, GDP, budget deficits, credit spreads, inflation rates, and corporate taxes, significantly influence corporate cash holdings.
This study adopts the logarithm of the cash ratio, defined as the natural logarithm of the sum of cash and marketable securities divided by net assets, as the dependent variable, in line with previous research (Baum et al., 2009; Opler et al., 1999) Different studies, such as those by Baum et al (2009) and Chen and Mahajan (2010), have explored various independent variables affecting cash holdings, including composite measures, interest rates, inflation, GDP, budget deficits, and credit spreads Our analysis specifically focuses on two critical factors—GDP growth rate and inflation rate—due to their significant fluctuations observed during economic crises.
Descriptive statistic
Variable Observations Mean Std Dev Min Max
This table summarizes the key statistics for the study's variables, including the number of observations, mean, standard deviation, minimum, and maximum values The analyzed variables encompass corporate cash holdings (CashTA), the presence of a crisis, cash flow to total assets (CFTA), revenue to total assets (ReTA), short-term debt to total assets (SDTA), real GDP growth rate (GDPg), and the inflation rate.
(Inflation), and firm size In detail, crisis take value 1 if firm operates during crisis period, and 0 if it operates during normal times
The table provides a detailed statistical overview of various financial factors related to businesses The CashTA variable, reflecting the ratio of corporate cash holdings, has an average of approximately 0.13 and a standard deviation of 0.124, suggesting a moderate degree of variability, especially during crisis periods.
The average cash flow to total assets (CFTA) is about 0.0755, indicating significant variation in cash flow among organizations The revenue to total assets (ReTA) metric averages slightly over 1, reflecting a general trend of positive revenue generation relative to total assets, but it also shows considerable variation, suggesting diverse revenue capacities across entities The short-term debt to total assets (SDTA) ratio averages around 0.109, with substantial variation indicating differing levels of leverage among firms Additionally, the macroeconomic environment is characterized by significant fluctuations in real GDP growth and inflation rates Firms tend to be of considerable size, with a mean value of approximately 13.1 and a smaller standard deviation, indicating less diversity in firm sizes Overall, the data highlights significant disparities in financial positions and macroeconomic conditions among companies, emphasizing the need for careful analysis.
Empirical Results
Regression results
In sections 3.2 and 3.3, CashTA is defined as the ratio of cash and cash equivalents to total assets of firms To account for consistent industry effects, we utilize industry dummies based on the four-digit NACER ev 2 classification Our regression analysis includes controls for fixed industry effects, acknowledging that cash levels may differ across industries due to their inherent characteristics.
(66.09) F(24,139859) = 228.57 Prob > F = 0.0000 R-square Within = 0.0377 corr(u_i, Xb) = -0.1109
Notes: This table presents the effect of crisis on corporate cash holding The coefficients of variables along with respective t-values (in parentheses) are shown and
***,** level of significance are reported accordingly
A regression study demonstrates a significant link between various characteristics and corporate cash holdings (CashTA) Specifically, crises correlate with a notable decline in cash holdings, evidenced by a negative coefficient of -0.0048688 at a 99% significance level This indicates that economic downturns lead to substantial reductions in cash reserves Conversely, factors such as cash flow to total assets (CFTA) and inflation positively impact cash holdings, while revenue to total assets (ReTA), short-term debt to total assets (SDTA), and business size negatively affect them The model's R-squared value of 0.0377 suggests it accounts for only a small portion of the variability in cash holdings Overall, the findings highlight the complex interplay between economic conditions, business characteristics, and corporate liquidity management practices.
The F-test is a statistical method used to compare variances across multiple groups and assess hypotheses related to parameters in a statistical model Evidence from the F-test suggests that individual-specific effects (ui) are significantly different from zero, which supports the application of a Fixed Effects model in the research.
Discussion
Statistics reveal a significant negative relationship between economic crises and corporate cash holdings, evidenced by a crisis variable with a coefficient of -0.0048688 and a t-value of -5.12 This suggests that during economic downturns, companies tend to reduce their cash reserves relative to their total assets As businesses face urgent challenges like maintaining operations and fulfilling short-term obligations, their cash-to-asset ratios decline This statistically significant finding underscores the vulnerability of corporate liquidity in tough economic times, emphasizing the importance of implementing strong cash management strategies to mitigate the effects of crises on cash reserves and enhance competitiveness in the global market.
Research by Almeida, Campello, and Weisbach (2004) indicates that during economic downturns, businesses typically reduce their cash reserves This behavior is driven by liquidity constraints and the necessity to allocate funds to immediate operational demands, highlighting the trend of firms holding less cash in challenging economic conditions.
During challenging times, companies often prioritize allocating funds to maintain operations or meet short-term obligations, making it difficult to retain cash reserves The model indicates that factors like high short-term debt (SDTA) and the revenue-to-asset ratio (ReTA) exert a more significant negative impact on cash holdings than one might expect, even when better cash flows (CFTA) could allow for increased cash storage during crises Specifically, the negative coefficients for ReTA and SDTA suggest that businesses with higher short-term debt or greater revenue relative to assets are less likely to hold cash, likely due to urgent debt repayment needs or rapid revenue cycles Notably, while macroeconomic indicators like GDP and inflation align with previous studies, a positive coefficient of 0.0222746 reveals that increased cash flow relative to total assets can influence cash retention.
Additional analysis: Corporate cash holdings impact on Firm
Theory
Businesses strive to achieve optimal performance, and several financial indicators are crucial for assessing a company's success One key metric is Return on Assets (ROA), which evaluates how effectively a company utilizes its resources ROA is calculated by dividing the organization's net profits after taxes by its total assets Additionally, cash holding refers to the accumulation of cash and highly liquid assets with a maturity period of less than three months, providing insights into a company's liquidity and financial health.
Cash holding refers to the accumulation of cash and assets, defined as the ratio of cash and cash equivalents to total assets (Gil & Shah, 2012; Vijayakumaran & Atchyuthan, 2017) While not a primary objective for many corporations, maintaining cash reserves is crucial as it enhances production efficiency, influences investment decisions, and ultimately impacts overall performance and value This has led to significant research on currency transaction record-keeping and the factors influencing organizations' cash hoarding decisions, explored through various theoretical frameworks, including trade-off theory, pecking order theory, and free cash flow theory Notably, the free cash flow theory indicates a negative relationship between cash holdings and firm performance, whereas both trade-off and pecking order theories suggest a positive correlation (Vijayakumaran & Atchyuthan, 2017; Rocca & Cambrea, 2018) Empirical studies further support this positive association between cash holdings and business performance.
Variable Fixed-effects (within) regression
Notes: This table presents the effect of crisis on corporate cash holding The coefficients of variables along with respective t-values (in parentheses) are shown and
***,** level of significance are reported accordingly
The table presents coefficients for various variables using Fixed Effects (FE) models, revealing that all financial and macroeconomic variables show significant results, with p-values less than 0.01 (indicated by **) for crisis-related factors and p-values below 0.001 (marked by ***) for the others.
The fixed-effects regression model identifies key factors influencing corporate cash holdings (CashTA) It finds that crises negatively affect cash holdings, evidenced by a coefficient of -0.0065853, significant at the 95% level However, the interaction term CashTA_Crisis indicates a positive relationship, suggesting a more complex connection between cash holdings and crises Additionally, both cash flow to total assets (CashTA) and revenue to total assets (ReTA) positively and significantly impact cash holdings, with coefficients of 0.1319362 and 0.0213943, respectively In contrast, the influence of short-term debt to total assets remains a critical consideration.
GDP growth and inflation rate positively impact corporate liquidity, while larger firm size also contributes unexpectedly, challenging earlier research findings These insights illustrate the intricate relationship between multiple factors, including crises, and their effects on corporate liquidity.
Discussion
Recent data reveals significant insights into the relationships between Cash to Total Assets (CashTA), CashTA during crises (CashTA_Crisis), and Return on Assets (ROA) CashTA demonstrates a notably positive coefficient of 0.1319, indicating its essential role in enhancing ROA, aligning with previous studies like Bates et al (2009) that highlight cash holdings as a crucial liquidity buffer for improving firm value Interestingly, the interaction term CashTA_Crisis also shows a positive impact on ROA with a coefficient of 0.0275, challenging the conventional risk-averse behavior suggested by Almeida et al (2004), which posits that firms typically conserve cash during crises Instead, our findings resonate with Campello et al (2011), indicating that financially robust firms continue to pursue investment opportunities even in challenging economic conditions, thus explaining the positive CashTA_Crisis coefficient.
The negative coefficient for the crisis variable (-0.0066) indicates that crises typically harm Return on Assets (ROA) However, this adverse effect is lessened when firms maintain higher cash reserves (CashTA_Crisis) This indicates that cash holdings can function as a dual asset: enhancing profitability in stable periods (CashTA and ROA) and acting as a safeguard during crises (CashTA_Crisis and ROA) These intricate relationships among cash holdings, crises, and ROA present significant opportunities for future research.
Conclusion
Conclusion
A study reveals a significant positive correlation between cash holdings (CashTA) and firm performance during economic volatility, particularly when analyzed through Fixed Effects models Companies with a higher cash-to-assets ratio tend to perform better in crises, benefiting from increased positive impacts on key performance metrics This highlights the importance of effectively managing cash reserves as a strategic financial resource, especially in uncertain times, and underscores the role of cash holdings in influencing return on assets and overall business success.
Limitation
To accurately evaluate the findings of this study, it is essential to acknowledge several limitations Firstly, the cross-sectional approach restricts the ability to draw causal conclusions regarding the relationship between cash on hand and return on assets (ROA), indicating that a longitudinal study could better illuminate this dynamic, especially amid changing economic conditions Secondly, the research overlooks industry-specific factors that significantly influence cash holdings and ROA, as industries with high capital expenditure or strict regulations may exhibit unique patterns not captured here Lastly, the study does not adequately address the complexities faced by multinational corporations, including varying cash holding requirements and associated risks, such as currency fluctuations.
Recommendation
The Fixed Effects models indicate significant positive coefficients for cash holdings ratio and cash flow to total assets (CFTA), highlighting the importance for businesses to maintain high levels of cash and cash flows relative to their total assets This strategy could enhance company performance and financial stability, particularly during crises, as evidenced by the substantial interaction between cash holdings ratio and Crisis Therefore, in times of volatility, it is advisable for companies to reassess their cash management practices to optimize outcomes.
Macroeconomic factors may not directly impact the variable under study due to the differing significance of elements like real GDP growth and inflation rates Future research is likely to enhance the accuracy of these interactions by utilizing diverse measures or exploring the effects of non-linear relationships.
To enhance research quality, it is essential to incorporate additional variables that reflect diverse aspects of firm performance and economic conditions, such as market volatility, interest rates, and corporate governance indicators Additionally, considering temporal factors through time-series analysis or examining the varying impacts over short-term versus long-term periods can provide deeper insights into these dynamics.
The analysis uncovers unexpected findings, notably the absence of significant relationships between Crisis and Return on Assets (ROA) and Real GDP growth and ROA Furthermore, it highlights that there is no correlation between Real GDP growth and ROA These insights suggest the need for further research, emphasizing the importance of including additional control variables, such as business age, market competition, and corporate governance metrics, to address potential omitted variable bias affecting ROA.
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