Passive and Proactive Motivations of Cash Holdings

We present a novel fact called the ``V-shaped relationship'' between firms' growth opportunities and cash holdings. Specifically, cash holdings are positively correlated with growth opportunities in firms experiencing positive growth but negatively correlated with those facing adverse growth opportunities. This divergent link suggests that the motivation for cash holdings varies between these two types of firms. To account for this V-shaped relationship, we develop a new numerical model in which a manager optimally determines the levels of investment and cash holdings in response to shocks that affect the corporate production process. A unique aspect of this model is that it incorporates the dual motives of cash holdings: cash serves as a cushion against an adverse shock and simultaneously allows the provision of agile money, thereby seizing a growth opportunity. Considering these passive and proactive motives for cash holdings enables the model to replicate the V-shaped link. Furthermore, we investigate the rise in corporate cash holdings in recent decades through the model and find that tighter borrowing constraints and lower interest rates after the global financial crisis account for more than 60% of the rise in corporate cash holdings.