The Role of Cash Holdings in Reducing Investment-Cash Flow Sensitivity: Evidence from a Financial Crisis Period in an Emerging Market
Posted: 10 Jun 2011
Date Written: February 11, 2006
Abstract
This paper investigates the relationship between financing constraints and investment cash flow sensitivities by focusing on cash holdings as the basic classification scheme to separate firms into finacially constrained and unconstrained categories. The idea is that high cash reserves increase the ability of firms to undertake profitable investment opportunities, especially of those firms that are exposed to greater market imperfections and, therefore, have difficult in accessing to external finance. Our classification scheme is based on an optimal cash model, which helps us to identify the firms that deviate significantly from their target cash ratio. We conduct the analysis for an emerging market, just before and during a financial crisis. The results show that constrained firms exhibit greater investment to cash flow sensitivities than unconstrained firms. Also, there is strong evidence that cash stands as a serious hedging device for firms mainly during the crisis period.
Keywords: Cash holdings, investment, financial constraints, financial crisis, emerging markets
JEL Classification: G31, G32
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