As Ross, Westerfield and Jordan (2000) report, at the end of 1997 a number of US companies piled up tremendous amounts of cash and marketable securities. At that time Ford held US $20.8 billion, GM US $14.5 billion, and Chrysler US $7.1 billion in liquid assets. This naturally raises the question for which reasons a firm would hold such large amounts of cash, and if there is an optimal amount of cash holdings. While this issue remained largely unexamined in the financial literature for years, recently, some researchers tried to explore the determinants of corporate cash holdings in the US (e.g. Opler, Pinkowitz, Stulz and Williamson, 1999) and in some European countries (e.g. Ferreira and Vilela, 2002). However, different reasons for holding cash might exist in countries with less developed economies. In this study, I examine the determinants of corporate cash holdings using a sample of companies listed at the New Zealand Stock Exchange in the 1980-2003 period.
This work is guided by three theoretical models which are helpful in finding the determining factors of cash holdings. However, these models partially disagree about how certain firm characteristics affect liquid asset holdings. The trade-off model assumes that companies weight the marginal benefits and the marginal costs of holding cash to decide on their cash holdings. Thus, firms have a target cash level to which they continuously try to adjust. Benefits of holding cash are for example the reduction of transaction costs, and costs related to holding cash are mainly opportunity costs.
The second model of corporate cash holdings is the financing hierarchy model. Ac-cording to this theory, firms want to avoid costs induced by asymmetric information and, therefore, use cash from retained earnings to finance investments before using debt or even equity.
Contents
1. Introduction
2. Theory of Corporate Cash Holdings
2.1 Static Trade-Off Model
2.2 Financing Hierarchy Model
2.3 Free Cash Flow Model
2.4 Additional Factors Influencing Corporate Cash Holdings
2.5 Summary of Theoretical Models
3. Review of Empirical Studies
4. Data
4.1 Data Description
4.2 Variable Definitions
4.3 Descriptive Statistics
5. Statistical Background
5.1 Introduction to Panel Data Models
5.2 Regression Methodologies
5.2.1 Fama-MacBeth Model
5.2.2 Cross-Sectional Regression
5.2.3 Time-Series Cross-Sectional Regression with Year Dummies
5.2.4 Fixed-Effects Regression
5.3 White Standard Errors
6. Empirical Investigations
6.1 Univariate Tests
6.2 Determinants of Corporate Cash Holdings
6.2.1 Basic Regressions on the Whole Data Sample
6.2.2 Regression with Cash Flow Variability and 1/Z-Score
6.2.3 Regression with Cash Flows from Cash Flow Statements
6.2.4 Regression Tests for Managerial Discretion
6.3 Investigation of Mean Reverting Characteristics
7. The Use of Excess Cash
7.1 Review of Current Literature on Excess Cash Holdings
7.2 Empirical Investigation of Excess Cash Holdings
8. Conclusion
A. Summary of Empirical Studies
B. SPSS Syntax Files
B.1 Syntax for Performing Regressions with White’s Standard Errors
B.2 Syntax for Performing a Series of Regressions
C. Additional Regressions
Objectives & Key Research Themes
This thesis investigates the determinants of corporate cash holdings among companies listed on the New Zealand Stock Exchange between 1980 and 2003, aiming to identify whether these firms maintain an optimal cash level and which factors influence their liquidity decisions.
- Theoretical analysis of cash holding motives based on trade-off, financing hierarchy, and free cash flow models.
- Empirical determination of influencing factors such as growth opportunities, leverage, and cash flow variability.
- Investigation into the existence of target cash levels and the speed of adjustment toward these targets.
- Examination of excess cash utilization, including capital expenditures, acquisitions, and dividend policies.
Excerpt from the Book
Static Trade-Off Model
According to the static trade-off model of corporate cash holdings, the amount of cash held by a firm is determined by weighting the marginal costs and the marginal benefits of holding liquid assets (see Ferreira and Vilela, 2002).
Using the assumptions that the only objective of managers is to maximize shareholder wealth, the only cost associated with holding cash is the lower return earned on it. These opportunity costs arise from the fact that the amount of cash held could otherwise be invested at a higher rate of return. Relaxing the assumption of shareholder wealth maximization as the only objective of managers, results in additional costs caused by corporate cash holdings. Managerial discretion allows for wasteful spending and acquisitions when large amounts of cash are under an manager’s control (see Dittmar, Mahrt-Smith and Servaes, 2003).
There are as well several benefits of holding liquid assets which counterbalance the costs associated with holding cash. First, cash helps to avoid transaction costs associated with the liquidation of existing assets or the raising of external funds. Second, cash enables a company to pursue the optimal investment policy and, therefore, prevents a company from rejecting positive NPV projects if external financing constraints are met. Finally, the danger of encountering financial distress is reduced by cash. If there are unexpected losses, a cash reserve acts as a buffer, especially, if external funding is difficult to obtain.
Summary of Chapters
1. Introduction: Presents the motivation for studying corporate cash holdings in New Zealand and outlines the three guiding theoretical models.
2. Theory of Corporate Cash Holdings: Discusses the trade-off, financing hierarchy, and free cash flow models as frameworks for corporate liquidity.
3. Review of Empirical Studies: Provides an overview of existing international research on the determinants of corporate cash holdings.
4. Data: Describes the sample construction and defines the financial variables and proxies used in the empirical analysis.
5. Statistical Background: Details the panel data regression methodologies and the implementation of White standard errors to account for heteroskedasticity.
6. Empirical Investigations: Presents the core regression results, univariate tests, and the analysis of mean-reverting characteristics of cash holdings.
7. The Use of Excess Cash: Examines how New Zealand firms utilize excess cash and investigates patterns in corporate spending.
8. Conclusion: Summarizes the key findings and links the empirical evidence back to the theoretical predictions of corporate cash management.
Keywords
Corporate cash holdings, New Zealand Stock Exchange, Static trade-off model, Financing hierarchy model, Free cash flow theory, Panel data regression, Managerial discretion, Excess cash, Financial distress, Capital market imperfections, Liquid assets, Mean reversion, Target adjustment model.
Frequently Asked Questions
What is the primary focus of this research?
The research examines the reasons why New Zealand companies maintain specific levels of cash and identifies the determinants influencing their corporate liquidity decisions over the 1980-2003 period.
Which theoretical frameworks guide this study?
The study is guided by three main theories: the static trade-off model, the financing hierarchy (pecking order) model, and the free cash flow theory.
What is the central research question?
The study asks why firms hold large amounts of cash and whether there exists an optimal target cash level to which firms continuously adjust.
What methodology is applied to the data?
The study utilizes panel data regression techniques, including Fama-MacBeth, cross-sectional, and fixed-effects models, adjusted for heteroskedasticity using White standard errors.
What does the empirical analysis cover?
The analysis covers the determinants of cash holdings, the robustness of these determinants through various sub-samples, and the investigation of mean-reverting behavior in cash levels.
Which keywords best describe this study?
Key terms include corporate cash holdings, New Zealand market analysis, trade-off theory, capital structure, and target adjustment models.
How is "excess cash" identified in this study?
Excess cash is identified by comparing the actual cash stated in a company's balance sheet against the predicted cash level derived from the regression model.
Does the study find evidence of target adjustment?
Yes, the results strongly support a target adjustment model, suggesting that New Zealand companies adjust their cash holdings toward an optimal target relatively quickly.
- Quote paper
- Anonym (Author), 2004, Why New Zealand Companies Hold Cash: An Empirical Analysis, Munich, GRIN Verlag, https://www.grin.com/document/23648