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The Role of Cash Holdings in Reducing Investment-Cash Flow Sensitivity: Evidence from a Financial Crisis Period in an Emerging Market

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  • Ozgur Arslan
  • Chrisostomos Florackis
  • Aydin Ozkan

Abstract

This paper investigates the relationship between financing constraints and investment-cash flow sensitivities by focusing on cash holdings of firms as the basic classification scheme to separate firms into financially constrained and unconstrained categories. The idea is that high cash reserves increase the ability of firms to undertake profitable investment opportunities. Our classification scheme is based on an optimal cash model, which helps us identify the firms that deviate significantly from their target cash ratio. We conduct the analysis for an emerging market, just before and during a financial crisis to test the hypothesis that the hedging role of cash is more critical in states of the world characterized by high asymmetric information and excessive costs of external finance. The results are in line with our expectations and show that constrained firms exhibit greater investment to cash flow sensitivities than unconstrained firms. Also, there is strong evidence that cash stands as an effective device for firms mainly, during the crisis period.

Suggested Citation

  • Ozgur Arslan & Chrisostomos Florackis & Aydin Ozkan, 2006. "The Role of Cash Holdings in Reducing Investment-Cash Flow Sensitivity: Evidence from a Financial Crisis Period in an Emerging Market," Discussion Papers 06/08, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:06/08
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    References listed on IDEAS

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    Cited by:

    1. Črnigoj, Matjaž & Verbič, Miroslav, 2014. "Financial constraints and corporate investments during the current financial and economic crisis: The credit crunch and investment decisions of Slovenian firms," Economic Systems, Elsevier, vol. 38(4), pages 502-517.
    2. Roberto Álvarez & Andrés Sagner & Carla Valdivia, 2012. "Liquidity Crises and Corporate Cash Holdings in Chile," The Developing Economies, Institute of Developing Economies, vol. 50(4), pages 378-392, December.
    3. Gary E. Powell & H. Kent Baker, 2010. "Management Views on Corporate Cash Holdings," Discussion Paper Series 2010-01, McColl School of Business, Queens University of Charlotte.
    4. repec:eee:riibaf:v:42:y:2017:i:c:p:480-495 is not listed on IDEAS
    5. Yung, Kenneth & Li, DeQing Diane & Jian, Yi, 2015. "The value of corporate financial flexibility in emerging countries," Journal of Multinational Financial Management, Elsevier, vol. 32, pages 25-41.
    6. repec:bla:ausecp:v:55:y:2016:i:4:p:368-385 is not listed on IDEAS
    7. Crisóstomo, Vicente Lima & López-Iturriaga, Félix Javier & Vallelado González, Eleuterio, 2014. "Nonfinancial companies as large shareholders alleviate financial constraints of Brazilian firm," Emerging Markets Review, Elsevier, vol. 18(C), pages 62-77.
    8. Ozgur Arslan & Mehmet Baha Karan & Cihan Eksi, 2010. "Board Structure and Corporate Performance," Managing Global Transitions, University of Primorska, Faculty of Management Koper, vol. 8(1), pages 003-022.
    9. Duchin, Ran & Ozbas, Oguzhan & Sensoy, Berk A., 2010. "Costly external finance, corporate investment, and the subprime mortgage credit crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 418-435, September.
    10. Milos Markovic & Michael A. Stemmer, 2017. "Firm Growth Dynamics and Financial Constraints: Evidence from Serbian Firms," Documents de travail du Centre d'Economie de la Sorbonne 17012, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    11. Jason Fewell & Cole Gustafson, 2010. "Do lender-imposed sweeps affect ethanol technology investment?," Agricultural Finance Review, Emerald Group Publishing, vol. 70(2), pages 169-183, August.
    12. Roberto Álvarez & Mauricio Jara-Bertín & Carlos Pombo, 2016. "Do institutional investors unbind firm financial constraints? Evidence from emerging markets," DOCUMENTOS CEDE 015114, UNIVERSIDAD DE LOS ANDES-CEDE.
    13. Carlos Carreira & Filipe Silva, 2012. "Where Are The Fragilities? The Relationship Between Firms' Financial Constraints, Size, And Age," Book Chapters, Institute of Economic Sciences.
    14. Álvarez, Roberto & Bertin, Mauricio Jara, 2016. "Banking competition and firm-level financial constraints in Latin America," Emerging Markets Review, Elsevier, vol. 28(C), pages 89-104.
    15. Heru Fahlevi & Muhammad Arfan & Hafidah Hafidah, 2016. "The Influence of Dividend Payments, Profitability, Liquidity and Firm Size for Cash Holdings ? Case of Indonesian Manufacturing Companies," Proceedings of International Academic Conferences 4106579, International Institute of Social and Economic Sciences.
    16. Frederick Adjei, 2013. "The effects of cash holdings on corporate performance during a credit crunch: evidence from the sub-prime mortgage crisis," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 37(2), pages 188-199, April.

    More about this item

    Keywords

    Cash holdings; investment; financial constraints; financial crisis; emerging markets;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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