The Correlation Between Static Tradeoff And Pecking Order On Cash Holdings

Decision on cash holdings is one of the most important issues on corporate finance. Lots of academic discussions came up, among which the controversy between static trade off and pecking order is the most tropic one. These two theories, which seem to be contradict, both have substantial reasoning and supporting empirical evidence. Based on the assumptions and spirit of them, we analyze how they are opposite and complementary; in seek of an improving theory that helps to explain cash holdings.According to statistics, we find that Chinese companies have higher cash holdings, lower cash flow, higher leverage and high PB, compared to their overseas counterparts. Based on return and cost analysis, we conclude our opinion as"Limited Choice". Assumptions centered on"The target of choice","The limit on choice"and"The outcome of choice"are examined:(I) Chinese listed companies do have their cash-holding target, as weighting return and cost and being affected by various factors;(II) Agency cost of debt restrains companies from keeping optimum liquidity;(III) Under the limit of agency cost of debt, companies are divided on cash-holding behaviors. Those with higher agency cost of debt have to give priority to debt target, thus are less capable to maintain their cash-holding target, while those with lower cost are more capable.Assumption I is supported by four set of multiple regression, along with dual effects of some variables. Assumption II is proved in view of substantially negative correlation between delta debt and delta cash holdings and positive volatility correlation between debt and cash. We divide the sample by agency cost of debt and do multiple regressions separately so as to support assumption III. Results show that those with higher agency cost of debt have significant cash-holding target, while those with lower have vague target.The contribution of this thesis is as follows:(1) In combination of two classic theories, we propose an improving one as"limited choice". We empirically prove that agency cost of debt impose limit on companies'ability to keep optimum cash holdings. Under higher agency cost, debt target are prioritized, cash holdings are compromised and violates; vice versa.(2) We study the affect of economic situation on cash holdings. When demand decreases, over-supply occurs, leverage rises, and efficient money demand lacks, enterprises would avoid expansion and stock cash in order to guard against risk.(3) We provide a different perspective to explain influences of scale, growth, CFO and leverage that they may individually have dual affects that offsets. Using operating cash net inflow of last 3 years to define"inflow effect", we find that CFO of current year does reduce cash holdings, which greatly differ from former studies.