Market Frictions and Ability to Invest: A Cash Holding Policy Perspective
47 Pages Posted: 10 Mar 2008
Date Written: January 2008
Abstract
This paper is an original attempt to analyse the effect of different cash holding policies on corporate investment decisions. In a dynamic framework, where firms have both present and future investment opportunities, corporate cash holding may secure the ability to invest in presence of market frictions. We distinguish two groups of companies that differ for their liquidity position relative to the estimated target cash. Our findings show that firms displaying a persistently low cash policy invest less in fixed assets. However, they do not appear to be more exposed to capital markets imperfections than other companies. They seem to have access to alternative sources of funds that enable them to increase "non-routine" investment and acquisitions in the future. On the contrary, we find that a persistently high cash policy has a strong significant impact on capital expenditures. Cash-rich firms show a significantly lower investment-cash flow sensitivity suggesting that these companies are less exposed to market frictions and to potential overinvestment issues. In addition, a strategy of accumulation of internal funds allows companies to invest more in high growth projects, complete planned acquisitions and increase dividend payment over time.
Keywords: cash holding policy, investment-cash flow sensitivity, ownership structure, GMM
JEL Classification: G31, G32, D92
Suggested Citation: Suggested Citation
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