Economic Policy Uncertainty and the Marginal Value of Corporate Cash Holdings

Abstract

This paper studies the relationship between economic policy uncertainty (EPU) and the marginal value of corporate cash holdings. We find that the markets place a lower value on firms’ cash holdings under the high level of EPU. Our quasi-experiment tests relating to the 9/11 terrorist attacks and gubernatorial elections support the causal relationship between EPU and the value of cash holdings. Furthermore, we show that this relationship is more pronounced for firms with less redeployable assets, reduced investments, more investment opportunities, poor corporate governance, or excessive cash. We also document a negative relationship between investment and future excess cash, which is amplified under the heightened EPU. Overall, we reveal that EPU reduces the market value of corporate cash holdings due to investment reductions.

Keywords: Cash holdings; Economic policy uncertainty; Investment

JEL Classification: G18; G30; G32