Almeida, Campello, and Weisbach (2004) and Riddick and Whited (2009) offer contrasting conclusions regarding the corporate cash flow sensitivity of cash. We use an augmented empirical model to affirm the conclusion in Riddick and Whited that the cash flow sensitivity of cash is generally negative. In addition, we contend that the cash flow sensitivity of cash is asymmetric to cash flow. The asymmetry may be due to several reasons, including binding project contracts, bad news withholding, and agency costs. Using a sample of manufacturing firms from 1972 to 2006, we document that the cash flow sensitivity of cash is negative when a firm faces a positive cash flow environment, supporting Riddick and Whited (2009), but the cash flow sensitivity of cash is positive when a firm faces negative cash flows. We further divide firms into financially constrained and unconstrained ones and find that the cash flow sensitivity of cash asymmetry continues to hold in both groups. When we use institutional holding as a control for the agency problem, we find that firms with better outside monitoring dissave to capture good investment opportunities. All the results support our hypotheses that firms have different levels of responses to their cash holdings when facing positive and negative cash flows.
Bibliographical noteFunding Information:
We acknowledge the helpful comments from an anonymous reviewer and the seminar participants at National University of Kaohsiung, Sun Yat-Sen University, Ling Tung University, and National Changhua University of Education. An earlier version of the paper was presented at the Asian Financial Association conference in Macau. Weining Zhang acknowledges the financial supports from National Natural Science Foundation of China on the projects #71102077 and #71002058. The usual caveats apply.
- Cash flow sensitivity
- Cash holdings