The Research On The Smoothing Effect Of Cash Holdings On Firms’ Investments

Investment and financing are the two most crucial and inseparable financialdecisions. Because of the irreversibility and high adjustment cost of investment, it’scostly for firms to change the level of investment expenditures, firms have stronginvestment smoothing motivation. Asymmetric information and contracting problemsbetween a firm and the providers of external funds make external financing morecostly than internal financing, and there is a lot of uncertainty in internal cash flow,these impede the realization of the objective whenever firms cannot costlessly offsetcash-flow fluctuations with external funds. As an important source of enterpriseinternal financing, cash holdings’ influence on investment has attracted more andmore attention in recent years. However, the role of cash holding in enterpriseinvestment smoothing objective realization and the mechanism how it works haverarely been studied.This paper first examines the smooth effect of cash holdings on firms’ investmentexpenditures based on the panel data of the listed companies in China A share marketfrom2000to2011, by using two-step system GMM estimators to estimate a dynamicinvestment model with financial variables reference to the Euler equation under theassumption of quadratic adjustment costs. The overall sample regression results showthat firm’s investment has a good inertia with high adjustment cost, there is a stronginvestment smoothing incentive for firms; current cash holdings increment has asignificantly reverse effect on firms’ investment expenditures, while the initial stockof cash holdings has a significantly positive impact on corporate investment spending,which indicates that firms can offset the impact of cash-flow shocks on investment bylowering the level of cash holdings to release short-run liquidity, allowing firms tosmooth investment relative to cash-flow shocks, and the extent that investments canbe smoothed depends on the initial cash stock.On this basis, through the grouping regression analysis, the paper focuses on theinfluence of financing constraints, hedge demand and the risk of cash flow three firmcharacteristics on cash holdings’ investment smoothing effect. The groupingregression results suggest that cash holdings have a significant smoothing effect oninvestments in severer external financial constrained firms or firms with higher cashflow risk or higher hedging needs, while there is no obvious smoothing effects of cash holdings on firms’ investment that their external financing constraints, operating cashflow risk or hedging needs are relatively lower. Furthermore, from inter-andintra-industry two dimensions, this article investigates the influence of industryconcentration, and the similarity of a firm’s operations with its rivals two industrycharacteristics on the smoothing effect of cash holdings on firms’ investment. Theempirical results show that, a firm in a high market concentration industry, and theindustry in which firms’ operations are more similar to their rivals, actively utilizecash holdings to sooth its investment; while there is no convincing proof that thosefirms in the industry with low market concentration and low business similarity withtheir competitor, use cash holdings to smooth investment.This study empirically examines the investment smoothing effect of cashholdings and analyzes its function mechanism, reveals the relationship betweencorporate liquidity and its investment decision-making, also further deepens theunderstanding of cash holding and its value. Our findings enrich the research resultson cash holding and investment, and provide theoretical basis and practice guidancefor corporate cash holding policy and investment decision.