The Determinants And Implications Of Corporate Cash Holdings In China

How many cash should a firm holds? It's one of the most important, also the most difficult financial decisions for a firm. According to Brealey and Myers(1996), how to determine the optimal cash holdings for a firm is one of the ten puzzles unsettled in the financial research field.From the firm level perspective, cash holdings reflects a firm's financial strategy as well as operating strategy, besides, inappropriate cash decisions will have a significant impact on future performance. From the macro-level perspective, my finding is different from the traditional view, which states that corporate cash holdings has a relation with the macroeconomic situation, but empiric evidence states that the yearly volatility of corporate cash holdings is similar with the volatility of Chinese stock market.This paper focuses on giving two answers: firstly, what are the determinants of corporate cash holdings in China; and do these determinants have a different impact on cash holdings in different periods; secondly, implications of cash holdings to future performance when firms deviate from their expected balances.Extending the model of Opler, Pinkowitz, Stulz and Williamson (1999), this paper provides a more comprehensive model of expected cash balances and finds evidence supporting a static tradeoff model of cash holdings, and featured with a stage characteristic. Further tests examine the implications to future return on assets (ROA) when firms deviate from their expected cash balance.The main findings of this paper include: Firstly, big firms, firms with a higher liquid debt-to-debt ratio and firms with a higher volatility in operation cash flow tend to hold more cash in hand. On the other hand, cash substitutions and free cash flow have a negative impact on corporate cash holdings. Evidences are found which support a static tradeoff model of cash holdings. Secondly, the determinants of cash holdings are featured with a time period characteristic. Particularly, in the period of 2001 to 2005, investment opportunities, says Growth in this paper, have a positive impact on cash holdings, which is accordance with tradeoff theory prediction. And the volatility of operation cash flows has no significance relation with cash holdings in two periods, which are 1998 to 2000 and 2006 to 2007. In a word, the determinants and cash holdings have volatility similarly with stock market. Thirdly, higher deviations (in absolute term) are associated with lower future ROA; (2) the aforementioned association is found in both positive and negative deviations; the effect of negative deviation on future ROA is stronger than that of positive deviation.Contributions of this paper include three main parts: firstly, introduced two new explanatory variables, which are Net External Finance and Free Cash Flow. With the two new variables, adjusted R square increased from 0.1816 to 0.6617, which is significantly higher than the 0.223 of Opler et al. (1999) model. Secondly, found evidence supporting the significant relationship between corporate cash holdings and stock market index. Thirdly, controversy with the evidences found in international and Chinese markets, Book-to-market value as a proxy for the future investment opportunity is not as that good.Forth, find that higher deviations (in absolute term) are associated with lower future ROA; the aforementioned association is found in both positive and negative deviations; the effect of negative deviation on future ROA is stronger than that of positive deviation.