Abstract - When does cash matter?

There is compelling evidence indicating that high cash holdings can reflect – or even lead to – agency problems that destroy shareholder value. There are also, however, well developed arguments for (precautionary) cash holdings increasing shareholder value. An important issue is when, or even whether, the precautionary use of cash adds value. Although it seems clear that firms that are more likely to face constraints hold more cash, it is less clear how these firms benefit from cash holdings or the types of firms that benefit most from cash holdings. Our results indicate an asymmetric relation between a firm’s size and its sensitivity to changes in industry conditions. In particular, small firms realize disproportionally larger losses (e.g., decrease in sales) during industry downturns than large firms but do not realize disproportionally larger gains during industry upturns. Among small firms, high cash firms outperform low cash firms during downturns. There is, however, no difference in performance between high cash and low cash small firms during upturns. For larger firms, there is little difference in performance between high cash and low cash firms during industry downturns or during upturns. Collectively, the findings indicate that cash holdings serve as a valuable hedge for small private firms against industry downturns. For large firms, which likely have greater access to external financing, the benefits of cash holdings as a hedge against downturns are limited.

Paul Ehling
BI Norwegian Business School
10.May 2011

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