Firm and country specific determinants of corporate cash holdings : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

After the 2008 Global Financial Crisis (GFC), firm cash holdings came to the attention of scholars. During the crisis, many non-financial firms faced severe liquidity shortage due to poor cash inflows and higher interest rates for external financing. This led to numerous cases of bankruptcy. Firms hold cash for two reasons. The first reason is to transaction costs associated with liquidating assets to cover daily operational costs. The second reason firms hold cash is to create a buffer to meet their obligations. Cash holding strategies determine a firm’s future growth and survival. However, if a firm holds too much cash, it can increase their opportunity costs. Holding large amounts of cash can also be costly as well, due to low or zero returns on idle assets and potential agency problems associated with free cash flows. Conversely, holding too little cash leads to low levels of investment. It can also lead to liquidity shortages, meaning that a firm is unable to meet its financial obligations. While previous studies (Baumol, 1952; Miller & Orr, 1966; Tobin, 1956) provide different cash holding strategies, these are theoretical in nature and may not have been tested empirically. In this study, we investigate the effect of firm-specific factors (working capital and the cash conversion cycle) and macroeconomic factors (the interest rate, the inflation rate, the foreign exchange rate, and economic policy uncertainty) on non-financial firms’ cash holdings. This is the first study that includes three types of factors: firm-specific variables, macroeconomic variables and macroeconomic uncertainty (economic policy uncertainty) in developed and developing economies. We examine firms in both developed and developing countries. Businesses obtain bank financing for investments purposes when they have insufficient internal funds. Firms typically mortgage their fixed assets to borrow money (Kiyotaki & Moore, 2002). Cash holdings are critical when firm cash inflows are insufficient to meet their capital demands. We choose two developed (the US and Japan) and two developing (China and India) countries. Our data is panel and we use firm-year observation for analyses. We divide our dataset into two configurations. First, we divide dataset according to time periods i.e., pre, post and during 2008 GFC for each country. Secondly, we divide our dataset into two groups (i) financially constrained and (ii) financially unconstrained. Financially constrained firms have easier access to financial markets which is crucial when faced with liquidity shortages. This is not the case for financially constrained firms. We apply the system generalized method of moments (SGMM) to overcome the problem of endogeneity and produce unbiased results. We find that financially unconstrained firms have higher cash inflows and assets (current and non-current) than financially constrained firms in developed and developing countries for the period of 2003 - 2015. We also find divergent results for developed and developing countries. The findings reveal that all independent variables (working capital, the cash conversion cycle, the interest rate, the inflation rate, the foreign exchange rate, and economic policy uncertainty) have a significant effect on cash holdings, for both financially constrained and unconstrained firms. The direction (positive/negative) of the relationship varies according to the country: that is, developed or developing. Our findings indicate that changes in the cash holdings of non-financial firms also depend on macroeconomic variables. Financially constrained firms have a propensity to increase cash to avoid liquidity shortages. Our results indicate that cash holdings are important for all non-financial firms in developed and developing economies. Cash holdings provide a financial buffer in times of crisis and enable firms to invest in positive NPV projects. This research thus endorses aspects of precautionary motive theory and transaction motive theory.