Determinants of Corporate Cash Holdings
C. Hobma, S. Labitzke, M. Munsterhuis, L. Zwols March 24, 2011
This paper examines what determinants explain corporate cash holdings of 1078 US rms listed on the New York Stock Exchange (NYSE) for the period January 1990 till December 2007. Using regression analysis with panel data we show that our ndings are in line with previous literature. Consistent with the trade o theory, we found a signicant positive relationship between rms' investment opportunities and their cash holdings. Furthermore, we found that larger rms hold relatively more cash which is in line with the pecking order theory. A dividend dummy shows that dividends can be regarded as a substitute for cash holdings. Finally, we found evidence that technology rms, which are associated with more uncertainty, hold more cash than nontechnology rms.
Corporate cash policy has become a topic of signicant interest recently. The investigation of determinants of corporate cash holdings is an important research area contributing to the understanding of how much cash a rm will hold. The added value of this paper is that it gives a comprehensive discussion of which theories underlie corporate cash holdings. Next to that, it investigates rm specic characteristics as well as industry characteristics that can inuence the level of corporate cash holdings based on a dataset of 1078 US rms listed on the NYSE for the period 1990 to 2007. This paper proceeds as follows. We rst examine the theoretical background concerning the determinants of corporate cash holdings. Theories that are discussed are the trade o theory, the pecking order theory and the free cash ow theory. Second, we discuss the research which already have been done concerning the relevant determinants. Investment opportunities, leverage, rm size, cash ows, dividends and industries will be discussed. In the third part, data and methodology will be discussed. Fourth, the empirical results of the regression are shown. Finally, this paper concludes with recommendations for further research.
In this section an overview will be given of the theoretical background of this article. The central question, what are the determinants of the level of corporate cash holdings, will rst be put in the light of three theories. First the trade o theory, then the pecking order theory and nally the free cash ow theory will be discussed. Those three theories relate to the capital structure of the rm. After these theories are discussed, an overview of existing literature is given for the direct determinants of the level of cash holdings. This will be a start for the hypotheses which are formulated later. In our article we will test with a regression analysis what the determinants of cash holdings are for our data set, these determinants are discussed in the next paragraph, where this paragraph gives a theoretical background.
2.1. Trade o theory
This theory states that there is an optimal capital structure for a rm. A rm should weigh the advantages and disadvantages of extra debt, where the advantages are the tax deductability and the smaller problems surrounding free cash ow. The disadvantages are the potential cost of nancial distress and agency costs arising between owners and nancial creditors. This optimal level of indebtedness is researched by [Myers, 1984], where he analyses the real debt ratio with the target or optimal level. With respect to our research, from a point of the trade o theory, an optimal level of cash should have to exist. Where on a rm level an optimum level of debt exist, there should also be a optimum level of cash. Here the advantages for holding cash is a lower risk of nancial distress, due to the possibilities to pay directly. Disadvantages can be found in the fact that a cash holding can not generate a positive NPV, due to the fact that there is no income for any amount of cash on a current...
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