Cash and Competition

49 Pages Posted: 14 Apr 2011 Last revised: 25 Jul 2011

Date Written: April 13, 2011

Abstract

This work studies the effects of competition on corporate cash holdings. I develop an industry equilibrium model in which credit constrained firms use liquidity reserves as a buffer against future cash shortfalls. Competition triggers two contrasting effects. First, it increases the option value to remain active in the market, reinforcing the precautionary motive for holding cash. Second, it induces the firms to reduce leverage and interest payments on debt. Lower debt payments require a smaller amount of cash reserves. Although the overall effect is potentially ambiguous, under realistic conditions, cash increases with competition. The model suggests that competition can explain the increase in cash holdings and the negative relation between leverage and cash observed in the data.

Keywords: Cash holdings, Competition, Capital Structure, Industry equilibrium

JEL Classification: D21, D53, D58, G31, G32, G33, G35

Suggested Citation

Della Seta, Marco, Cash and Competition (April 13, 2011). Available at SSRN: https://ssrn.com/abstract=1808979 or http://dx.doi.org/10.2139/ssrn.1808979

Marco Della Seta (Contact Author)

APG - Asset Management ( email )

Gustav Mahlerplein 3
Amsterdam, 1082 MS
Netherlands

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
388
Abstract Views
3,014
Rank
139,955
PlumX Metrics