Determinants of Corporate Cash Holdings and its Implication: Evidence from Pakistan’s Corporate Sector.


This study examines the determinants of corporate cash holdings and their implications for nonfinancial firms by pursuing three main objectives. The first objective examines firm­specific factors that determine the optimal level of corporate cash holdings. The second objective necessitates re­analyzing the effect of corporate governance on corporate cash holdings and the third objective examines cash holding behavior under macroeconomic uncertainty. Results on the determinants of corporate cash holdings, using firm specific factors, is consistent with some of the theories such as information asymmetry theory, financial distress hypothesis and the transaction costs hypothesis that suggests that the higher fixed processing fee for obtaining external financing discourages smaller firms to go for external financing and hence prompting them to hold more liquid assets. Nevertheless, these results support the argument of Opler et al. (1995). They suggest that larger firms have more capacity to accumulate cash since they are presumably more profitable. The results also suggest that Pakistani companies are sensitive to the volatility of cash flow and that firm’s cash holdings are highly influenced by a precautionary need.

Higher financial leverage tends to increase the probability of financial distress because of the pressure that rigid amortization plans put on the firm’s funds management. This implies that firms with higher leverage ratios would tend to hold higher levels of liquid assets in an attempt to reduce the probability of experiencing financial distress. Further, financially constrained firms also have incentives to maintain large cash balances as they face constraints to raise external capital. Our empirical results also lend support to the argument that high growth firms hold larger amounts of cash in order to ensure realizing expected future benefits, even if the capital is not available externally. Next, the coefficient for the capital expenditure has a significant negative relationship to the firm’s cash holdings. The cash flows, used in this study as a proxy for financial motives, are positively related to the corporate cash holdings of the firms suggesting that organizations having larger cash flows hold larger cash on their balance sheet. This may lend credence to the argument that credit market frictions are responsible for high correlation between cash holding and the cash flow of the firm. Results also indicate that there are no differences in the patterns of cash holdings between the group­affiliated and the non­group businesses

Results for the effect of corporate governance on cash holding behavior are in line with the finance literature which suggests a role for effective corporate governance in disciplining managers and weak governance may lead to a tendency of the managers to hold excess cash holdings. The results of this study are also in line with the interest alignment hypothesis. Finally, the institutional ownership may not be a relevant factor in explaining corporate cash holding patterns for Pakistani firms. This may be quite understandable as the role of the institutions in the corporate governance is very limited, almost nonexistent in Pakistan’s corporate sector. For the relationship between macroeconomic uncertainty and variation in the cross­sectional dispersion of cash ratio of corporate firms, results provide support to the hypothesis that uncertainty in macroeconomic variables leads firms to similar cash holding behavior since uncertainty in the macroeconomic environment can affect the manager’s ability to predict their future cash flows.

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