Financial Development and the Cash Flow Sensitivity of Cash

38 Pages Posted: 3 Jan 2006

See all articles by Inder K. Khurana

Inder K. Khurana

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Raynolde Pereira

University of Missouri at Columbia - School of Accountancy

Date Written: July 7, 2005

Abstract

Prior research has posited that market imperfections and the lack of institutions which protect investor interests create a divergence between the cost of internal and external funds, thereby constraining firms' ability to fund investment projects through external financing. One consequence of financial constraints is that it forces firms to manage their cash flows to finance potentially profitable projects. A related stream of research documents that financial constraints due to costly external financing are more pronounced in underdeveloped financial markets. In this paper we examine the influence of financial development on the demand for liquidity by focusing on how financial development affects the sensitivity of firms' cash holdings to their cash flows. Using firm-level data for 35 countries covering about 12,782 firms for the years 1994-2002, we find the sensitivity of cash holdings to cash flows decreases with financial development. We also consider additional implications of firms' cash flow sensitivity of cash with respect to firm size and business cycles. Overall, we provide new cross-country evidence on the role of financial development on financial constraints.

Keywords: financial development, cash

JEL Classification: G31, G32, D23, D92, O16

Suggested Citation

Khurana, Inder and Martin, Xiumin and Pereira, Raynolde, Financial Development and the Cash Flow Sensitivity of Cash (July 7, 2005). Available at SSRN: https://ssrn.com/abstract=873145 or http://dx.doi.org/10.2139/ssrn.873145

Inder Khurana

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business ( email )

331 Cornell Hall
Columbia, MO 65211
United States
573-882-3474 (Phone)
573-882-2437 (Fax)

Xiumin Martin

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

Raynolde Pereira (Contact Author)

University of Missouri at Columbia - School of Accountancy ( email )

337 Cornell Hall
Columbia, MO 65211
United States
573-882-6253 (Phone)