An Empirical Study On Effect Of Financing Constraints On Firm's Cash Policy

Two important areas of research in corporate finance are the effects of financial constraints, and the manner in which firms perform cash management. These two issues, although often studied separately, are fundamentally linked. In inefficient and incomplete markets, the cost of external financing will be different from internal financing because of the asymmetric information among market participants, agency problems, transaction costs and so on, therefore, comes the problem of financial constraints. Under this circumstance, firms' investment will depend on internal cash-flow in a certain extent. When the liquidity arises, it allows the firms to undertake valuable project, so liquidity is relevant for the inter-temporal allocation of capital. The fixed costs induce firms to raise external funds infrequently and to use cash holdings as a buffer; therefore firms will save cash out of their cash flow in a systematic way. Besides, for the diversity of financial constraints among different enterprises, they have been demonstrated different characteristics in aspect of cash holdings -cash flow sensitivity.This paper explores the effect of financial constraints on firms' cash holdings under the assumption that managers act at shareholders' benefits. Using a sample of 416 listed manufacturing companies of Shanghai and Shenzhen stock markets from 2002 to 2006, and chooses the firm size, firm age, fixed charge coverage, dividend payout rate and another new classification scheme based on the account information derived from balance sheet and profit and loss accounts as the standard of financial constraints grouping to study detailed the effect of financial constraints on relationship between cash holdings and cash-flow and the optimal level of cash holdings. Based on a three-period investment-and-financing model, we reach the inferences: the cash flow sensitivity of cash holdings is always positive for financial constrained firms; their cash flow sensitivity of cash holdings will become smaller as the constraints are alleviated. The financial unconstrained firms display no clear systematic relationship between cash holdings and cash flow.The empirical examination shows: The financial constrained firms do display the positive sensitivity, and their cash flow sensitivity of cash holdings do become smaller as the constraints are alleviated. The unconstrained firms also follow suite, but the sensitivity coefficient is higher than the financial constrained counterpart. We suppose that the results above are due to the level of sensitivity is affected, apart from the precautionary savings, by future investment opportunities captured partly by the cash flow variable. Hence, the highest sensitivity of unconstrained firms simply reflects the high growth opportunities of this group of firms. While constrained firms save cash to hedge the fluctuations in their cash flow, unconstrained firms may save to boost future investments. Hence, cash flow works as an inter-temporal allocation of capital. ACW's ''liquidity irrelevant" hypothesis can't hold in China's capital market, cash flow sensitivity of cash can not provide a reliable evidence for those firms facing different financial constraints. No mater what the external financing condition is, firms all choose to save their cash flow in a systematic way.