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Accounting for the corporate cash increase

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  • Zhao, Jake

Abstract

Why do U.S. firms hold much more cash now than they did 40 years ago? I construct a partial equilibrium model of firm dynamics where cash provides a buffer against persistent and transitory cash flow shocks in the presence of costly external finance. I find that 57% of the increase in cash holdings of small public firms can be accounted for by the observed decrease in the correlation between revenue and operating expenses. The decrease in the correlation between revenue and expenses is then decomposed and explained. The model has a corresponding correlation parameter between the shocks on revenue and expenses and allows for the possibility of negative cash flows. Negative cash flows are frequently observed in the data and the frequency has a significant impact on optimal cash holdings. Finally, a lower corporate tax rate and cash restrictions are imposed on the model as policy experiments.

Suggested Citation

  • Zhao, Jake, 2020. "Accounting for the corporate cash increase," European Economic Review, Elsevier, vol. 123(C).
    • Handle: RePEc:eee:eecrev:v:123:y:2020:i:c:s0014292120300258
    DOI: 10.1016/j.euroecorev.2020.103393
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    Cited by:

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    2. Macnamara, Patrick, 2019. "Taxes and financial frictions: Implications for corporate capital structure," Journal of Economic Dynamics and Control, Elsevier, vol. 101(C), pages 82-100.
    3. Begenau, Juliane & Palazzo, Berardino, 2021. "Firm selection and corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 139(3), pages 697-718.
    4. Xiaodan Gao, 2018. "Corporate Cash Hoarding: The Role of Just-in-Time Adoption," Management Science, INFORMS, vol. 64(10), pages 4858-4876, October.
    5. Curtis, Chadwick C. & Garín, Julio & Saif Mehkari, M., 2017. "Inflation and the evolution of firm-level liquid assets," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 24-35.
    6. Adão, Bernardino & Silva, André C., 2020. "The effect of firm cash holdings on monetary policy," European Economic Review, Elsevier, vol. 128(C).
    7. Levine, Oliver, 2017. "Acquiring growth," Journal of Financial Economics, Elsevier, vol. 126(2), pages 300-319.
    8. Chase P. Ross & Landon J. Ross, 2022. "Cash-Hedged Stock Returns," Finance and Economics Discussion Series 2022-055, Board of Governors of the Federal Reserve System (U.S.).
    9. Albertus, James F. & Glover, Brent & Levine, Oliver, 2022. "Foreign investment of US multinationals: The effect of tax policy and agency conflicts," Journal of Financial Economics, Elsevier, vol. 144(1), pages 298-327.
    10. Ryosuke Fujitani & Masazumi Hattori & Tomohide Mineyama, 2024. "Passive and Proactive Motivations of Cash Holdings," Working Papers e200, Tokyo Center for Economic Research.
    11. Armenter, Roc & Hnatkovska, Viktoria, 2017. "Taxes and capital structure: Understanding firms’ savings," Journal of Monetary Economics, Elsevier, vol. 87(C), pages 13-33.

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    More about this item

    Keywords

    Cash increase; Revenue-expense correlation decrease; Transitory shocks; Negative cash flows; Precautionary savings;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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