Amsterdam Business School
Have Cash-rich Firms
Benefitted from the
Financial Crisis?
An econometric analysis of cash holdings of firms
with financial constraints and their market share
Master Thesis
MSc. Business Economics
Finance Track
Student
Renée de Both
Student number 10382569
Supervisor
Dr. T. Caskurlu
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Abstract
This research investigates the impact of large cash holdings on market share growth in times of financial turmoil. The Difference-in-Difference model is used to estimate the effect of cash in relation with limited external financing during the financial crisis. Three forms of access to external capital are taken into account to find a causal relationship, since this identification study uses debt maturity of private debt, having a bond rating for public debt and unused credit line ratio for credit lines. An econometric analysis is applied by using the Arellano-Bover / Blundell-Bond estimator. The empirical results suggest that cash-rich firms having difficulty in external financing are not able to significantly increase their market share relatively more during the financial crisis than cash-poor firms. However, a significantly negative relationship is found between cash-rich firms having limited access to bond markets during the financial crisis and market share growth, as the results indicate that a one-standard deviation increase in cash holdings leads to a 34.3% decrease in market share growth. Therefore, it is concluded that cash-rich firms have not benefitted from the financial crisis by gaining a larger market share.
Statement of Originality
This document is written by Renée de Both who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
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Table of Content
1. INTRODUCTION ... 5
2. LITERATURE REVIEW ... 9
2.1DETERMINANTS OF CASH HOLDINGS ... 9
2.2ACCESS TO CAPITAL AND INVESTMENT POLICY ... 16
2.3MARKET COMPETITION ... 21
3. METHODOLOGY ... 24
3.1HYPOTHESES ... 24
3.2RESEARCH MODEL ... 27
4. DATA AND DESCRIPTIVE STATISTICS ... 31
4.1DATA COLLECTION AND SAMPLE ... 31
4.2SUMMARY STATISTICS ... 34
5. RESULTS ... 40
5.1REGRESSION DIAGNOSTICS AND ESTIMATOR ... 40
5.2MAIN RESEARCH MODEL... 44
5.3ADDITIONAL ANALYSES ... 51
6. ROBUSTNESS CHECKS ... 59
7. CONCLUSION ... 64
8. REFERENCE LIST ... 69
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List of Tables & Figures
Tables
Table 1 Summary Statistics of Sample Period p.35
Table 2 Distributional Test Treated vs. Non-Treated Firms for 2007 p.39
Table 3 Main Regression Analysis p.45
Table 4 Regression Analyses with Variations in Dependent Variables p.52 Table 5 Regression Analyses with Different Market Characteristics p.56
Table 6 Shapiro-Wilk W Test p.76
Table 7 Breusch-Pagan / Cook-Weisberg Test p.76
Table 8 Ramsey RESET Test p.76
Table 9 Link Test p.77
Table 10 Variance Inflation Factor Test p.77
Table 11 Arellano Bond Test for Autocorrelation p.77
Table 12 Robustness Checks for Firm Size, Variation in Lagged Cash and Manufacturing Firms p.78 Table 13 Robustness Checks for Extreme Positions of Firms regarding Cash and Constraints p.80 Table 14 Robustness Checks for Variations in Thresholds of the Financial Constraints p.82
Table 15 Summary of Main Results Related to Hypotheses p.84
Table 16 Summary of Robustness Checks Related to Main Hypothesis p.85
Figures
Figure 1 Tests for Normality of Residuals p.75
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1. Introduction
A few decades ago cash holdings were considered as an asset firms should not accumulate and investors were suspicious when firms held large positions of cash. According to Jensen (1986), one should expect firms with large cash holdings to have agency problems. However, since 1980 an increase in average cash holdings at U.S. firms has been documented (Bates et al., 2009). Since then there has been a paradigm shift in the literature and several studies emphasize the advantage of holding a large cash position.
Moreover, the financial crisis has revived academic interest in how firms manage their liquidity. This is because firms’ access to capital is considered a crucial determinant of surviving the financial crisis. Nonetheless, for certain firms survival has not been an issue and they have tended to focus on how to exploit the financial turmoil in the market to their competitive advantage. Their favorable competitive position could be due to the accumulation of large cash holdings of firms. When firms obtain an advantageous position compared to firms facing financial difficulties, they possibly seek to increase their market share. The following quote from John Chambers, CEO of Cisco Systems, exemplifies the superior position several firms experienced during the financial crisis:
This is my fifth downturn over the last 20 years. We’ve always gained market share and emerged stronger than we went into it. . . . In each of those, we went into them with kind of a playbook, if you will, of what we run our plays on during economic tough times. And we’ve tweaked them over the years but haven’t changed it dramatically. Then we develop a game plan for the uniqueness of the given economic challenge. So where we are today is we are at a time that, having learned from 2001, we go into this one with $34 billion in cash. (McKinsey & Company, 2009)
This research investigates the relationship between cash holdings and market share growth when firms face external financial difficulties during an economic downturn. The financial crisis, which was the most severe economic crisis since The Great Depression in 1929, is seen as the period following the bankruptcy declared by Lehman Brothers in September 2008. The pre-crisis period started in the third quarter of 2007 and hence, consequences were apparent in 2008, as banks had difficulties in retrieving debt (Almeida et al., 2009). Therefore, this research focuses on the period around 2008 and intends to answer the following research question: Have cash-rich firms benefitted from the
6 There have been abundant studies about the determinants of cash holdings and the reasons for its increase in the existing literature. The five cash determinants which are extensively discussed in the literature review consist of the agency theory, pecking order hypothesis, transaction motive, repatriation tax consequence and the precautionary motive. According to amongst others Bates et al. (2009), most of these determinants do not explain the increasing trend of cash holdings.
However, in contrast to the other cash determinants, the precautionary motive seems to be an appropriate determinant to explain the increase in cash holdings and the real effects of cash during the financial crisis. This is because the precautionary theory argues that firms hold larger cash reserves to secure themselves against adverse cash flow shocks when access to capital is costly and is supported by studies of, amongst others, Opler et al. (1999), Almeida et al. (2004) and Acharya et al. (2007). In addition, Irvine and Pontiff (2008) and Palazzo (2012) find that the idiosyncratic risk of firms increases, leading to a higher precautionary demand for cash levels.
The situation for which firms accumulate cash according to the precautionary determinant, was particularly the case during the financial crisis, as firms were associated with a large increase in risk, negative cash flow shocks and limited access to capital. According to Duchin et al. (2009), Almeida et al. (2009) and Campello et al. (2010), firms adjust their investments downwards when they face financial constraints. Hence, these studies suggest that it is important to ensure a sufficient level of cash to avoid a shortcoming of financing valuable investment opportunities.
When firms cut investments because of a lack of internal or external capital, there might be an opportunity for cash-rich firms to gain market share. This is in line with the findings of Fresard (2010), that firms accumulating cash are able to realize an increase in market share growth over the next two years. In addition, Haushalter et al. (2007) and Hoberg et al. (2014) find that market considerations affect firm’s policy to accumulate cash, which indicates the importance of cash holdings as a strategic position in the market. As Fresard (2010) suggests, precautionary behavior leads to real benefits. This results in the main hypothesis of this research: Cash-rich firms which are
subject to limited access to external capital are able to increase their market share during a financial crisis relatively more than cash-poor firms facing similar external financial constraints.
Nevertheless, the 2008 credit crunch might lead to different implications of the precautionary motive for market performance. As a result, firms might accumulate more cash instead of sticking to their initial investment policies and keep away from any action to aggressively compete to gain a larger market share during financial turmoil. Other theories also raise questions about the ability of cash-rich firms to increase their market share during the financial crisis. Harford and Uysel (2014) suggest that financially constrained firms are more subject to monitoring by capital markets because of higher chances of default. In contrast, cash-rich firms using internal capital are not monitored by the
7 capital market. This results in less external monitoring and is a concern based on the agency theory. Additionally, Almeida et al. (2009) stipulates that cash-rich firms pay off debt during crises to avoid financial distress costs, which may lead to less focus on beating competition in the market. Finally, another cause for concern is related to the repatriation tax consequence. Although Pinkowitz et al. (2012) do not find evidence for repatriation tax to explain the increase in cash holdings, they argue that U.S. multinationals hold on average 3% more cash than purely domestic firms. This tax may lead to minimal use of foreign cash holdings, resulting in no gain in market share for cash-rich firms. From these studies it can be concluded that the answer on the research question and the verity of the hypothesis are not straightforward and contribute to the existing literature.
This research investigates the causal effects of cash holdings on market share growth when firms face difficulty in external financing during the financial crisis. It contributes to the existing literature by incorporating three forms of access to external capital. This is in order to overcome the identification problem of financial constraints and to analyze the benefits of cash in financially limited conditions. These financial sources consist of private debt, public debt and credit lines.
The first identification that is used to overcome the endogeneity issue is a large proportion of debt maturity of private debt in the first year after the start of the financial crisis, as used by Almeida et al. (2009). This is an exogeneous shock, since it is assumed that the schedule to refinance long-term debt right after the start of the financial crisis is random and is bad luck to the firm. If debt matured during the financial crisis, it ought to be difficult to renegotiate with banks on new debt and it might be harmful to the firm to repay the debt.
Having a bond rating is incorporated to identify access to public debt, as done by Faulkender and Petersen (2006) and Harford and Uysel (2014). Both researches outline that firms with a bond rating have access to corporate bond markets, since firms facing growth opportunities but without having a bond rating are scarce. Hence, it is assumed that the lack of a bond rating is caused by an effect of the supply-side of the bonds and thus, is not due to shortcoming of the firm’s rating demand. Therefore, having no bond rating before the start of the financial crisis leads to limited access to public debt in 2008, as banks are relatively less eager to issue bonds to non-rated firms.
Finally, the unused credit line ratio is used in order to account for the limited access to credit lines, as proposed by Acharya et al. (2013). The maximum amount of credit firms can use is predetermined in a commitment. Hence, it is assumed that the undrawn balance of credit lines in 2008 is exogeneous, as the commitments were made before the start of the financial crisis.
These three treatments are analyzed in relation with cash after the start of the financial crisis in the Difference-in-Difference model and the Arellano-Bover / Blundell-Bond estimator is used to estimate the model, which is a contribution to the contemporary literature as well. The empirical
8 analysis is applied to a dataset which contains 11,122 observations, consisting of 1,624 firms with observations from 2004 to 2012. The data are retrieved from secondary databases.
In additional analyses, the model is subject to several variations of the main research model. Other dependent variables are used, including change in market dominance, change in return on assets and bankruptcy to give additional insight into potential benefits of high cash levels. Subsequently, the model is applied to different market conditions. The analysis is performed in markets divided into low and highly concentrated markets, as cash holdings have stronger effects increasing with the amount of strategic interactions (Fresard, 2010). Finally, the analysis is performed in low and high capital intensive markets, since certain industries are capital intensive and hence, more sensitive to limited access to capital to finance investments (MacKay and Philips, 2005).
The empirical results show that cash-rich firms facing limited access to external capital are not able to significantly increase their market share relatively more during the financial crisis than cash-poor firms. This may be explained by the above mentioned theories that firms do not use their cash holdings to gain market share, as the repatriation tax consequence suggests and that firms rather pay off their debt. Moreover, there is found a significantly negative relationship between cash-rich firms facing limited access to bonds during the crisis and their market share. The results indicate that a one-standard deviation increase in cash holdings leads to a 34.3% decrease in market share growth. This decline might be due to the mentioned concern based on the agency theory. At last, it is concluded that firms with large cash holdings have not benefitted from the financial crisis in terms of gaining more market share.
This research proceeds as follows. In section 2, the literature review first discusses the five determinants of cash holdings in order to give full insight into the benefits of cash. In the second part, the impact of financial constraints on investment is discussed and the sources of access to capital are evaluated. Section 2 ends with the discussion about the impact of financial constraints on market competition. In the methodology in section 3, the hypotheses are derived and the research model is described to report how empirical evidence is gained. The first part of Section 4 discusses how data is collected and prepared to build the dataset, the second part describes the summary statistics. Section 5 evaluates the regression diagnostics and estimator. Subsequently, this section reports the results of the empirical analyses of the main research model and the additional analyses. The robustness checks in section 6 test the validity of the results. Finally, section 7 concludes the research and discusses limitations, implications and suggestions for future research.
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2. Literature Review
In the first part of the literature review, five determinants of cash holdings are discussed in order to give insight into what the firm’s motives are to hold a certain level of cash. Subsequently, it is argued which determinant is predictive for the increase in cash holdings during the last decades and which one is important for this research. In the second part, the effects of limited access to capital on the investment policy are discussed and different sources of access to capital are examined. Finally, the impacts of financial constraints and cash holdings on the performance in the market are reviewed.
2.1 Determinants of Cash Holdings
There has been a paradigm shift in the literature with regards to the optimal level of cash holdings of firms. A few decades ago, Jensen (1986) argued that firms with large cash holdings are expected to have agency problems. This theory explains that cash should be used to invest in positive net present value investment opportunities or otherwise, cash should be returned to shareholders in the form of dividends or share repurchases. When firms hold larger cash holdings than necessary, corporate management has the incentive and the ability to act in their own interest instead of the interest of the shareholders, since both interests are not aligned. The management has the incentive to grow the firm more than the optimal size of the firm. A larger firm usually increases management’s power and bonuses, since the firm size and compensation pay are often related to each other. With more cash on hand, managers have control over more resources and extract private benefits from this. Therefore, entrenched managers are reluctant to pay out cash as dividends. A low level of cash leads to more monitoring by the capital markets when managers need to raise capital to fund investments. Jensen (1986) calls this the free cash flow theory and argues that firms should have a low as possible level of cash, otherwise agency costs become apparent. Free cash flow is considered as excess cash after the required cash is used to invest in all positive investment projects and is therefore prone to be used for negative value investments by the firm’s management.
This implication is in line with the pecking order hypothesis which is introduced by Myers (1984). According to this incremental financing theory, the firm’s management prefers to use internal capital first to finance investments, since cash is the least costly resource. Myers (1984) outlines a few assumptions. The dividend payout policy is set according to the investment opportunities. Although, the target dividend payout is sticky and only smoothly adjusted to avoid bad signaling to shareholders, abrupt changes in share prices and asymmetric information costs. This is because the dividend signaling theory suggests that an upwards change in dividend payouts indicates a positive change in profitability or a negative change in investment opportunities. Evidence suggests there is a positive market reaction after dividend initiations equal to plus 3.4% and after dividend omissions equal to -7% (Michaely et al., 1995). Similar results are found in the early study of Healy and Palepu
10 (1988). However, not all evidence is consistent, since it has been difficult to find a positive relationship between dividend changes and realized future earnings (Benartzi et al., 1997). Consequently, according to Myers (1984), sticky dividend policies, unpredictable fluctuations in profitability and investment opportunities lead to the use of cash by management. In case external finance is required to finance investments, management issues equity only as a last resort because of bad signaling. Issuing equity indicates that management is unable to obtain debt, because it cannot afford to pay interest expenses, or it signals that the share price is overvalued and thus interesting to issue shares for a high price. Therefore, if managers are forced to use external finance, they start with debt. The pecking order hypothesis of Myers (1984) does not suggest an abusive use of cash as Jensen (1986) does. Nevertheless, it also indicates that firms should have a low as possible level of cash to give a good signal, since managers have the preference to use cash first to fund investments. Cash holding implicates that no positive investment projects are available and therefore, cash gives a bad signal.
However, since 1980 an increase in average cash holdings at U.S. firms has been documented (Bates et al., 2009). The average cash-to-assets ratio of U.S. firms more than doubles from 10.5% in 1980 to 23.2% in 2006 or increased by 0.46% per year. Due to improvements in information and financial technology one would expect the level of cash holdings to be decreased, since these innovations provide firms to hedge more effectively as more types of derivatives have become available. This may lead to less need for cash holdings because of less variation in profitability and reduced uncertainty.
The question arises why U.S. firms hold increasingly more cash these days and therefore, there have been quite some studies that investigate the determinants of corporate cash policies. Since then the literature shifts from a more critical view regarding cash holdings towards a more positive attitude about higher levels of cash. Several studies emphasize the advantage of holding a large cash position. In the following part, five sets of determinants are discussed to provide the firm’s motives of cash holdings.
An important determinant of corporate cash holdings, the previously discussed agency theory of Jensen (1986), is extensively investigated in recent studies. Dittmar et al. (2003) examine 11,000 firms from 45 countries and find that firms in countries with poor shareholder rights, thus poor corporate governance, hold more than double the cash holdings of firms in countries with good shareholder protection. This result is consistent with the agency cost theory of Jensen (1986) and indicates that shareholders who face poor protection are less able to monitor the corporate managers to payout excessive cash.
11 In a later study, Dittmar and Mahrt-Smith (2007) investigate the difference between the cash value in firms with poor and good corporate governance. They find that corporate governance has a substantial impact on the value and use of cash holdings. One dollar of cash in a firm with poor governance is only worth $0.42 to $0.88 and firms with good governance have values almost twice as large. In addition, poorly governed firms spend cash quickly, leading to reduced operating performance. This result is in line with the importance of corporate governance to monitor managers in the decision-making about the way cash holdings should be used.
Pinkowitz et al. (2006) also conclude that cash is worth less when corporate governance is poor. They find that in countries with poor shareholder protection, cash holdings and firm value are much weaker related to each other and that a dollar of liquid assets has a lower value. One of their results suggests that one dollar of liquid assets has a value of $0.91 in countries with more than average investor protection and has only a value of $0.33 in countries with low investor protection. When dividends are sticky and current dividends are high, high future dividends and lower consumption of private benefits are expected. Pinkowitz et al. (2006) investigate whether this is the case and find that a 1% dividend payout rate of a firm’s assets increases firm value by 9.80% in countries which are considered to have less corporate governance. The increase in firm value is only 4.07% in other countries. They conclude that dividend payments are important to increase the value of poorly governed firms.
As Dittmar and Mahrt-Smith (2007) find, Harford et al. (2008) argue that entrenched managers build excess cash reserves and spend the liquid asset quickly. In contrast with the previously discussed studies, they find that firms with less corporate governance have lower levels of cash. Their analysis suggests that management of these firms spend cash more quickly and specifically spend the cash on acquisitions, which is in line with the agency cost theory of manager’s empire building. Results indicate that these investments decrease future earnings, which is reflected in the share price. Harford et al. (2008) highlight the importance of how excess cash is spent, as he concludes that cash is spent to enhance empire building.
These studies regarding the agency theory of cash imply that the level of corporate governance is highly interrelated with cash holdings and point out that the level of cash should be as low as possible to mitigate the ability of entrenched managers to use cash for their own interests. With a growing attention to corporate governance the last decades, one would expect the level of cash to be decreased. Nevertheless, with respect to the findings of the increasing trend in cash holdings, the question arises how important agency costs are and whether poor corporate governance plays a role in the larger cash holdings of firms.
Contrary to what Jensen (1986) suggests, Bates et al. (2009) provide evidence that agency problems do not contribute to the increase in cash holdings. They analyze the correlation between
12 managerial entrenchment and the level of cash and show that firms with the most entrenched managers experience the least increase in cash holdings.
Cunha (2014) also finds that it is less likely the case that cash leads to lower firm value when management accomplishes acquisitions and raises additional funds from financing sources such as debt. Cash holdings that are actively accumulated appear to be the result of liquidity management decisions, while larger cash holdings that are passively accumulated through operational surpluses are indeed value-destroying.
These recent studies suggest that the increasing trend of cash holdings should not be disadvantageous for firm value by definition and imply that there is room left for other important determinants of cash.
The pecking order theory, which is discussed previously, determines that firms should have low levels of cash. This is because, everything else equal, firms that invest more, accumulate less cash. Nonetheless, Shyam-Sunder and Myers (1999) do not support the pecking order hypothesis. They focus on the financing deficit obtained from information in the corporate accounts and the impact on corporate debt. If the pecking order hypothesis is correct, each component of the financing deficit should have an equal effect on corporate debt. However, Shyam-Sunder and Myers (1999) do not find evidence consistent with this financial hierarchy, therefore falsifying the pecking order hypothesis.
Frank and Goyal (2003) also test the predictability of the pecking order theory, using a broad cross-section of publicly traded U.S. firms for 1971 to 1998. Their conclusion is similar to the study of Shyam-Sunder and Myers (1999) and argues that net equity issues are more closely related to financing deficit than net debt issues do. The results indicate that financing deficits are not an important cause of net debt issues of firms. From this it can be concluded that the pecking order theory introduced by Myers (1984) is not an appropriate determinant of the increase in cash holdings in the following decades.
Two early classic studies that recognize one of the primary functions of cash holdings, build a model recognizing the need for a certain level of cash. Baumol (1952) argues that cash reserves serve as an exchange that can be immediately given up at an appropriate moment, as it is a liquid asset and useful to bargain. Miller and Orr (1966) derive the optimal demand for the level of cash and analyze the transaction demand of cash. These models imply that a firm faces transaction costs when converting a non-cash financial asset into cash. There are economies of scale associated with this transaction determinant. Large firms tend to have relatively less cash, as they are exposed to relatively less transactions. One of the studies supporting these economies of scale is executed by
13 Mulligan (1997). He finds that large firms hold smaller cash holdings as a percentage of sales compared to small firms.
This transaction determinant indicates that firms should have a certain level of cash to use cash as a liquid and flexible medium of exchange. However, according to Mulligan (1997), the amount does not need to grow proportionally with the size of the firm. One would also expect that firms and financial intermediaries have become more efficient in managing transactions, hence a lower level of cash is required for transactions. Therefore, the transaction determinant is not likely to be the factor of the increasing trend in cash holdings.
Another determinant for the level of cash is the tax consequence associated with repatriating foreign earnings. Foley et al. (2007) analyze the effect of this tax burden on the size of the cash holdings of firms. They find that firms that have to deal with higher repatriation taxes hold higher levels of cash, as there are higher costs involved when transferring cash from subsidiaries. In addition, their findings suggest that firms facing these higher taxes hold cash abroad and in affiliates to avoid repatriation costs. This study indicates that repatriation tax is a determinant of holding cash and that U.S. multinational firms are more likely to accumulate cash in their foreign subsidiaries.
Pinkowitz et al. (2012) find that U.S. multinational firms hold on average 3% more cash than purely domestic firms in the U.S. during the 2000s, while in the late 1990s these firms had similar levels of cash. This indicates that especially multinationals accumulate their cash holdings. In addition, U.S. multinational firms increase their cash holdings more with respect to foreign multinationals by roughly 3% as well. These findings emphasize the consequences of the U.S. repatriation taxes for cash holdings. Nonetheless, the analysis of Pinkowitz et al. (2012) suggests that the larger cash holdings of multinationals cannot be explained by this tax burden.
The tax determinant indicates that firms do not aim to reach large cash holdings, but tend to avoid additional costs associated with repatriating foreign cash and that U.S. multinationals are likely to have larger cash holdings. However, the 2004 Jobs Creation Act allowed firms to repatriate cash held in foreign countries at a substantially lower tax rate. Bates et al. (2009) investigate whether this event has an impact on the level of cash to analyze the tax determinant. As the findings of Pinkowitz et al. (2012), evidence suggests that the increase in cash holdings is not caused by avoidance of repatriation tax. Specifically, the average cash ratio of firms without foreign taxable income increases from 14.3% in 1990 to 25.3% in 2006, while the cash ratio of firms with foreign taxable income is 10.8% in 1990 and increased to 20.2% in 2006 (Bates et al., 2009).
Contrary to Foley et al. (2007), Pinkowitz et al. (2012) and Bates et al. (2009) argue that the tax determinant does not explain the increase in cash levels. Therefore, it is difficult to conclude that the repatriation tax is a reason for the increasing trend of cash holdings. In their studies, they also
14 find no evidence that a lack of investment opportunities, regulation or bad corporate governance explain the increased cash holdings of U.S. firms after the crisis. This brings us to the final determinant of the level of cash, the precautionary motive of holding cash.
According to the precautionary demand for cash theory, firms hold larger cash reserves to secure themselves against adverse cash flow shocks when access to capital is costly. The precautionary determinant also suggests that firms with better investment opportunities hold a higher level of cash, because in case of adverse shocks and financial distress it is more costly for these firms to bypass valuable investment opportunities.
The findings of Opler et al. (1999) are consistent with this determinant of cash holdings. The results indicate that firms with strong growth opportunities and riskier cash flows have relatively higher levels of cash normalized by total non-cash assets. Firms that have access to capital markets to a large extend, such as large firms with high credit rating, have smaller cash holdings. Also, they find evidence that firms with good performance increase their cash holdings more than expected to maximize shareholder’s value. Evidence that excess cash has a large effect on capital expenditure, acquisition and payouts to shareholders in the short run is limited. Instead, Opler et al. (1999) argue that the main causes of large changes in cash holdings are the firm’s operating losses.
Almeida et al. (2004) also investigate the importance of cash in cases of limited access to capital and conclude that financially constrained firms build cash reserves as a buffer against potential shocks in credit supply. They test the cash flow sensitivity of cash of financially constrained firms with respect to unconstrained firms and obtain significant estimates that constrained firms save around 5-6 cents per dollar, while unconstrained firms save nothing. Hence, the precautionary determinant predicts the cash level of financially constrained firms.
Han and Qiu (2007) find similar results as Almeida et al. (2004), but conclude that the precautionary determinant is caused by a tradeoff between today’s investment and future investment. They use a two-period investment model to analyze the precautionary determinant and find that financially constrained firms are sensitive to cash flow volatility, because financial constraints lead to an inter-temporal tradeoff. This implies that when future investments are relatively more attractive, but future cash flow risk is not diversifiable, financially constrained firms have the incentive to increase their cash holdings.
Ridick and Whited (2009) also examine why firms increase their cash holdings on the basis of the precautionary theory. They find that cash savings and cash flows are negatively related, because after receiving lower cash flows, firms do not use their cash reserves to invest. The results show negative propensities to save out of cash flow. In addition, uncertainty regarding income has also an
15 impact on saving, even more than financial constraints do. Therefore, their analysis also shows a positive relationship between risk and cash holdings.
Acharya et al. (2007) indicate that firms accumulate cash instead of reducing debt when future investment opportunities and income shortfalls are expected. They argue that firms which issue debt and accumulate cash, transfer income from high cash flow states to fund investment opportunities in low cash flow states. Their result indicates a hedging motive behind cash and debt policies and suggests that cash should not be considered as negative debt when firms face financial constraints.
The study of Bates et al. (2009) emphasizes the importance of the precautionary motive for holding cash reserves and suggests that this determinant plays an important role in the increase of cash ratios. They find that industries with the smallest increase in risk increased their cash holding by less than 50%, while industries with the largest increase in risk increased their cash holdings by more than 300%.
The innovations and growth in the derivative markets and the improvements in analyzing forecasts suggest a lower precautionary demand for cash holdings. However, evidence suggests that risk is an important factor in the precautionary theory. According to Campbell et al. (2001), idiosyncratic risk has increased. They study the volatility of common stocks at the market, industry and firm level and conclude that from 1962 to 1997 there has been a substantial increase in firm-level volatility with respect to market volatility. Therefore, the number of stocks required to achieve a portfolio of diversified stocks has increased.
Irvine and Pontiff (2008) also indicate that the volatility of stock return is substantially larger than the total market volatility. They estimate idiosyncratic risk to increase by 6% per year. This result comes along with an increase in the idiosyncratic volatility of fundamental cash flows, which is consistent with the efficient market hypothesis. Irvine and Pontiff (2008) argue that this is due to the more intense economic competition.
These changes in idiosyncratic risk and higher volatility in undiversified risk ask for a larger precautionary demand for cash holdings and may be a factor of the increased cash holdings during the last decades. This implication is supported by evidence of Palazzo (2012). He finds supporting results for his model that explains that riskier firms are more likely to fund investment opportunities by external financing and have higher levels of cash. This finding is in contrast with the pecking order theory, but indicates the importance of the precautionary determinant of cash holdings.
Therefore, the precautionary motive of firms to accumulate cash is the most appropriate determinant of the increase in cash holdings during the last decades and is the most appropriate
16 determinant to explain the level and the real effects of cash holdings during the financial crisis. This is because the financial crisis is associated with a large increase in risk, financial constraints and limited access to capital. According to Pinkowitz et al. (2016), the financial crisis does not seem to have an impact on the recent levels of cash. During the financial crisis, firms in the whole world decreased their cash holdings and accumulated their cash holdings again afterwards, as the precautionary determinant suggests. They investigate whether U.S. firms hold more cash than foreign firms and conclude that this is not the case for neither U.S. multinationals nor domestic U.S. firms. They argue that country characteristics have insignificant effects on the difference in cash holdings between U.S. firms and foreign firms. This is in contrast with the findings of Damodaran (2005), who concludes that firms in emerging countries and countries with weaker financial development and poor investor protection should hold more cash. There is no evidence that indicates that the determinants of cash holdings have changed during the financial crisis (Pinkowitz et al., 2016).
However, from the early literature criticizing large cash holdings, more recent literature sheds some light on the advantages of cash holdings nowadays as well. Specifically, the precautionary motive of holding cash is supported by the literature and may predict the increase in cash levels. In contrast with the discussed literature thus far that investigates the determinants of cash holdings, this research focuses on the real effects of the level of cash on firm performance in the market and the implications of the precautionary motive during the financial crisis. Therefore, in the next paragraph we will look more deeply into the consequences of financial constraints for corporate cash and investment policy.
2.2 Access to Capital and Investment Policy
As discussed, the precautionary determinant of cash holdings is to secure firms against adverse shocks in cash flows when access to capital is costly or difficult to obtain. This situation was exactly the case during the financial crisis, which was in the U.S. at its peak in the fall of 2008 after Lehman Brothers declared bankruptcy. Firms were considered to be financially constrained during the financial crisis, especially firms that rely on external finance, as access to capital was limited. Nonetheless, firms which were able to rely on internal finance, may be considered as less financially constrained. This difference in constraints during the financial crisis could lead to different adjustments of the initial investment policy, since financial constraints require firms to adjust. The question arises how firms act in these different situations, whether they adjust their investment policy when facing financial constraints.
In early studies regarding investment and financial structures, it is generally assumed that the financial structure is irrelevant to investment. This is because external funds provide a perfect
17 substitute for internal capital. Therefore, in perfect capital markets, the firm’s investment decisions are not related to the firm’s financial condition. Modigliani and Miller (1958) provide this basis for a theoretical approach of perfect capital markets and emphasize the irrelevance of financial structure and financial policy. However, markets are not frictionless and hence, external and internal capital are not perfect substitutes. Fazzari et al. (1988) acknowledge this imperfection and link the conventional theory of investment to the recent literature on capital market imperfections of that time. They argue that conventional models apply to mature companies with well-known expectations. Although, they do not find this for non-maturing firms. Their results suggest that financial effects on investment are the largest when market frictions are likely to be most severe. This finding of Fazzari et al. (1988) reinforces the implications financial constraints have on investment.
Kaplan and Zingales (1997) investigate the relation between financial constraints and investment-cash flow sensitivities, the level of responsiveness of firms regarding their investment policy on changes in the cash flow. They suggest that firms with less financial constraints have significantly greater sensitivities than firms with more financial constraints. Kaplan and Zingales (1997) argue that higher investment-cash flow sensitivities do not explain that firms are more financially constrained. This finding contradicts the finding of Fazzari et al. (1988) and asks for more detailed research.
Povel and Raith (2001) find results that are likely to explain this contradiction in the empirical literature. They argue that both a lack of internal fund and asymmetric information are measures of financial constraints and worsen the financial position of the firm. However, they have a different impact on investment, since the marginal cost of debt changes. More asymmetric information leads to higher costs and hence, lower investment. On the other hand, investment becomes more sensitive to changes in internal fund and the relationship between them is U-shaped. Povel and Raith (2001) suggest that the positive, negative or zero impact on the investment depends on the level of internal funds.
Almeida et al. (2002) propose a model of corporate liquidity management. When firms have access to positive NPV investment opportunities and are not able to fund them with external financing, firms accumulate cash holdings to fund those investments. Firms without financial constraints are able to undertake all positive NPV investments regardless of their level of cash. Nonetheless, financially constrained firms determine their cash level by the value of current investments with respect to the value of future investments. The model of Almeida et al. (2002) predicts that constrained firms accumulate liquid assets and take hedging, dividend and borrowing policies into account as well. Their empirical results support this model and the precautionary motive of firm’s holding higher levels of cash as well.
18 Campello et al. (2010) investigate the effects of credit constraints during the financial crisis. They study whether corporate policy decisions differ when firms are credit constrained according to the CFO. They surveyed 1050 CFOs from the U.S., Europe and Asia and find that constrained firms cut deeper in tech spending, employment and capital spending. In addition, they find that in order to fund investments, firms dissipate more cash reserves, used more credit lines and sold more assets. Their evidence also indicates that the inability to borrow externally caused many firms to bypass attractive investment opportunities. 86% of CFO’s of constrained U.S. firms argue that their investment policy was restricted during the financial crisis. More than 50% of the CFOs mentions that they cancel or postpone planned investment. The study of Campello et al. (2010) suggest that firms adjust their investment policy according to their ability to raise money to finance investments.
Duchin et al. (2009) analyze the impact of financial positions of firms on corporate investment. Their results indicate that firms with small cash reserves, high short term debt or financial constraints significantly decreased their investment during the financial crisis. In addition, firms that operate in industries which are dependent on external finance decreased their investment as well. They estimate that corporate investment declined by 6.4% following the onset of the financial crisis. Duchin et al. (2009) argue that the impact decreases in the third quarter of 2008, as the effects became more clear. On the basis of their additional analysis, they argue that the precautionary determinant of holding cash plays an important role during the financial crisis. This is because internal financial resources mitigated the supply shock and their results indicate that post-crisis investment is positively related to cash holdings. Hence, this finding suggests that it is interesting to explore the real effects of cash holdings during the crisis on the performance of firms.
According to Almeida et al. (2009), the identification strategy that is used by Duchin et al. (2009) is not clean enough, as they use only the financial crisis as an exogeneous shock to financial resources to analyze corporate investment. Almeida et al. (2009) analyze a similar study and find that financial constraints have a negative impact on investment as well. However, the exogeneous event they use to identify financial constraints is long term debt maturity in the year following the third quarter of 2007. This event is exogeneous since the schedule to refinance long term debt right around the financial crisis is assumed to be random and is just bad luck to the firm. It is considered being difficult for firms to renegotiate on new debt during this financial turmoil. Therefore, Almeida et al. (2009) argue that these credit constraints force firms to adjust their investment behavior. In additional analysis, evidence suggests that firms responded by using the least costly source of fund, namely cash, to finance investments and firms used their cash reserves to pay off their debt as well.
Faulkender and Petersen (2012) also investigate the effect of capital constraints on investment, but then in the light of the American Jobs Creation Act. The lower marginal tax regarding
19 the repatriation of foreign earnings is used by them as a temporary shock to the cost of internal financing. They find that a majority of the foreign cash is repatriated by firms which are not considered to be financially constrained. However, results suggest that financially constrained firms, which repatriated cash because internal cash level were too low to fund their investment, increased their investment significantly by 2.6% of total assets more per year than unconstrained firms. This result of Faulkender and Petersen (2012) indicates that when levels of cash are too low, firms adjust their investment policy according to their access to internal capital.
Therefore, evidence suggests that it is important to ensure a sufficient level of cash to avoid any bypass of valuable investment opportunities. This is also concluded by Almeida et al. (2014) after reviewing the literature regarding corporate management of liquidity. They argue that financial constraints and efficient investments are key factors in liquidity management. In addition, CFOs consider decisions and policy about corporate liquidity as one of their most important tasks of decision-making (Graham and Harvey, 2001). This is because they feel responsible to find a way to finance investments which are proposed by the CEO.
Hence, corporate liquidity and investment policies are highly dependent on financial constraints, which in turn depends on the access to capital. There are three forms of access to capital regarding debt and all three had their implications during the financial crisis. The implications of access to debt capital for firms during a credit crunch are outlined in the following part.
The most obvious access to debt is private debt, which comes in the form of bank loans. As previously discussed, Almeida et al. (2009) investigate the impact of the credit crunch during the financial crisis on corporate investments. They conclude that firms with a proportion of more than 20% long-term debt maturing in the following year after the third quarter of 2007 decreased their investment significantly. Interestingly, they also find that firms rather tend to decrease their investments than to cut dividends. Other studies investigate the determinants of debt maturity as well. Barclay and Smith (1995) explore the firm characteristics regarding the capital structure and find that specifically large firms with few growth options have more long-term debt in their capital structures. Stohs and Mauer (1996) conclude that asset maturity is positively related to debt maturity. In addition, Guedes and Opler (1996) suggest that large firms which are investment-graded borrow either very short-term debt or very long-term debt, while firms which are speculative-graded borrow more moderate short- or long-term debt. These evidences emphasize the importance of credit loans and their maturity during the financial crisis when accessing debt capital.
Another access to debt for firms is public debt, which comes in the form of corporate bonds. Faulkender and Petersen (2006) argue that the source of capital has an impact on capital availability
20 as well. They find that firms which have access to public bond markets have significantly more debt in total, by identifying having access as having a bond rating. In addition, firms with a bond rating have fundamentally different characteristics, but these differences do not lead to a significantly positive relation with debt. Their estimates suggest that firms with access to bond markets have 35% more debt. Harford and Uysal (2014) build further on their findings and investigate whether differential access to capital affects investments. They find that firms having access to public bond markets, thus having a bond-rating, are likely to increase acquisitions by more than 4.6%. Therefore, the study of Harford and Uysal (2014) support the theory that the source of funding has an impact on the ability to undertake investments. It can be concluded that not only the ability of having access to capital on itself has an impact on financial constraints, but the source of debt capital as well. From here one can conclude that during the financial crisis, the bond rating of firms has a large impact on firms’ financial constraints.
The third source of debt capital are credit lines. The key feature of a line of credit is that due to a credit commitment for a specific time period a firm can use credit in case the firm needs it. This allows the firm to access a predetermined amount of credit, but without paying the full interest of the whole period in case the credit line is not used. So, it is considered as a liquidity insurance for firms. The early study of Boot et al. (1987) emphasize the benefits of credit lines for borrowers and show a model based on asymmetric information when the firm faces a liquidity shock. They argue that credit lines work just as options and are like put options for the borrower. During a liquidity shock when firms experience high interest rates in the market, they can use credit lines and borrow at the predetermined low rate. In return, firms pay a commitment fee in advance. This suggests that firms with revolving lines of credit are advantaged with respect to firms without credit commitments during the liquidity shock of the financial crisis. Though, credit lines and bank liquidity are related, since declines in credit lines are backed by the bank’s liquidity and banks are able to threaten with additional covenants with the aim to cancel the revolving lines of credit (Acharya et al., 2013). The question arises whether firms are able to rely on credit lines or have to accumulate their cash reserves instead. Acharya et al. (2013) try to answer this and conclude that riskier firms have a higher ratio of cash to credit lines and face higher costs. This is because banks ask higher prices for credit lines to riskier firms and thus firms choose to hold more cash instead. In addition, they find that in times of higher financial risk banks issue less credit commitments, ask higher costs and shorter maturity and as a result firms increase their cash holdings. Acharya et al. (2013) argue that firms with idiosyncratic liquidity risk use credit lines and that firms with correlated liquidity risk use cash in addition to credit lines. This finding is in line with the results of Sufi (2009). He reports that credit lines are a substitute for liquidity if firms have large cash holdings and this is not the case for firms with low levels of cash. He argues that small cash holdings do not comply to the covenants of banks
21 and indicates that this lack of access has an impact on financial constraints. On top of that, Lins et al. (2010) finds that CFOs use cash holdings to hedge risk during bad times and use credit lines to undertake investment opportunities during good times. These evidences indicate that during the financial crisis, a period with highly correlated risk, credit lines are not as beneficial as concluded previously and cash holdings are an important determinant of liquidity. However, revolving lines of credit may be beneficial for firms with high levels of cash.
Since debt maturity, bond rating and credit commitments have implications for financial constraints and the access to capital, it is important to take these factors into account when evaluating the impact of cash holdings during financial turmoil. This is because private debt, public debt and credit lines are not perfect substitutes for cash holdings during the financial crisis. Therefore, this research uses these three identifications of financial constraints in relation to cash holdings in order to investigate the benefits of high levels of cash for the market performance during the financial crisis.
2.3 Market Competition
After discussing the implications of access to capital on investment policies and the implications of different sources of debt capital, one might assume that when firms face financial constraints the level of cash can play an important role in the investment policy. Since the financial crisis had a large impact on firms’ financial constraints, firms were forced to adjust their investment policy during this period. However, cash-rich firm may be relatively less forced to deviate from their initial investment strategy, in which they might have the opportunity to grow relatively more than cash-poor firms and to potentially gain a competitive advantage in the market. The interaction between firms, suppliers, customers, employees and other agents in the competitive market gives an additional dimension to corporate policy during financial difficulties.
Chevalier and Scharfstein (1996) find implications of financial constraints in the product market. Their results suggest that during macroeconomic recessions, financially constrained firms relatively raise their market prices more to increase their short-run profits, with respect to less financially constrained firms. This competitive disadvantage might decrease the firm’s market share and leads to potential increased market share for firms with less financial constraints which are not forced to raise market prices.
Campello (2003) analyzes the effect of the capital structure on the price markup and the market share in the product market. He uses shocks to aggregate demand in order to investigate the competitive performance when both the market environment and firms’ incentives to compete are affected. Therefore, he identifies the change in GDP as a macroeconomic shock and finds that
22 leverage has a negative impact on the firm’s market share. His analysis focuses on the debt level of firms and its effect on product market outcomes, but his result raises questions about the ability of accessing debt capital to fund investments and the impact on the firms’ market share.
In a later study of Campello (2006), he proposes that the debt level of firms can both positively or negatively affect the market outcome. By using the creditor valuation of firm assets in liquidation as exogeneous event, he analyzes the relation between debt and sales performance within industries. The results indicate that firms with moderate debt are associated with higher sales relative to competitors and that firms with high debt levels are underperforming in their respective markets. He emphasizes the importance of an optimal level of debt.
Mikkelson and Partch (2003) find that large cash holdings facilitate higher growth of operating income normalized by operating assets and that large cash holdings are accompanied by more investment and more growth in assets. This evidence implies the potential that cash-rich firms have to increase their market share relative to cash-poor firms.
Haushalter et al. (2007) add another interesting dimension from market competition to corporate policy and indicate that market considerations have an impact on corporate cash and hedging policies. Their results specifically suggest that when firms face higher risk of aggressive competition of rivals, firms accumulate more cash and hedge more with derivatives. This finding highlights the importance of cash holdings as a strategic position in the market.
Additionally, Hoberg et al. (2014) investigate whether market threats explain corporate cash and dividend policy. Their results suggest that competitive threats decrease dividend payouts and increase cash holdings. They argue that when firms pay lower dividends and repurchase fewer shares, thus accumulating cash and increasing the flexibility, they are more able to compete aggressively in the market.
Finally, Fresard (2010) investigates the implication of firms’ large cash holdings on their market performance. He analyzes the impact of higher levels of cash on the market share of the firms by using asset tangibility to instrument for cash and by using a variation in industry-level import tariffs as a quasi-natural experiment. He suggests that cash-rich firms gain more market share and the results are even stronger when competitors face financial constraints or when the market is more competitive. However, his identification of financial constraints relies on the proxies of debt level, asset size and rating. Therefore, shocks to financial constraints are not taken into account, like for example the previously discussed shocks to access to capital during the financial crisis. As Fresard (2010) suggests, precautionary behavior leads to real benefits. Nonetheless, the 2008 credit crunch is a unique case in this setting and might lead to different implications for market performance. The precautionary determinant of cash holdings suggests that firms rather accumulate the level of cash as insurance than to stick to their initial investment policy. It may be the case that this is especially
23 true during a macroeconomic downturn. As a result, firms may be extremely careful and keep away from any action to aggressively compete during a financial turmoil to gain a larger market share. Therefore, the implications of the precautionary determinant during the financial crisis are doubtful.
There are also theories that raise questions about the ability of cash-rich firms to increase their market share during financially difficult times. Harford and Uysal (2014) argue that firms with financial constraints and limited access to capital are more subject to monitoring by the capital market because of larger chances of default. This implies that firms with access to internal capital to fund investments might undertake less qualified investments. Monitoring of corporate decisions by capital markets may keep managers from overinvesting and a lack of monitoring eventually results in the disability to obtain a larger market share in their competitive market.
Another concern which is put forward by Almeida et al. (2009) is the payoff of debt to avoid financial distress costs. Cash-rich firms with financial constraints possibly prefer to pay off their debt to engage less in costly leverage instead of sticking to their initial investment policy to beat competition in the market.
In addition, the ability of cash-rich firms to increase the market share could be subject to the specific industry or characteristics of the market. Fresard (2010) investigates the implications for different markets and find that cash holdings have differential effects on the amount of strategic interactions. His results indicate that cash-rich firms are significantly more able to increase their market share in competitive markets compared to concentrated markets. The level of concentration in a market depends on the amount of firms that are competing in an industry.
Finally, one concern is that some industries rely more on investment and therefore, are more sensitive to limited access to capital to finance investments. MacKay and Philips (2005) investigate the financial structure and find that the firm’s debt level depends on the firm’s position within its industry and the industry characteristics. They argue that capital intensity is highly related to specific industries, where capital intensity is defined as the amount of capital relative to labor activity. Therefore, the existing literature asks for additional analyses to investigate whether the performance of cash-rich firms depends on the industry or the characteristics of the market they compete in.
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3. Methodology
In this section it is explained how empirical evidence is gained in order to answer the research question. In the first part it is clarified how the hypotheses are derived from the literature review and in the second part the research model is formulated to show how the hypotheses are tested. Furthermore, additional analyses are outlined and their corresponding hypotheses are mentioned.
3.1 Hypotheses
This research aims to achieve more insight into whether cash-rich firms benefitted from the financial crisis by gaining a larger market share, despite the fact that these firms face financial constraints. This analysis elaborates on the study of Fresard (2010) in which it is concluded that firms with higher cash holdings are able to obtain a larger market share within their market. This research investigates whether this conclusion holds during the financial crisis, when firms face financial constraints. This is because the precautionary determinant of holding cash might have different implications during financial turmoil. The precautionary motive to accumulate cash is to secure firms against adverse shocks in cash flows when access to capital is costly or difficult to obtain, which was particularly the case during the financial crisis (Opler et al., 1999; Almeida et al., 2004; Acharya et al., 2007). In addition, firm’s idiosyncratic risk has increased these days (Irvine and Pontiff, 2008; Palazzo, 2012). This leads to a higher precautionary demand for cash levels. However, it may be the case that firms behaved differently and extremely carefully during the financial crisis, as they faced macroeconomic downturn. As a result, these firms might avoid any action to aggressively compete to gain a larger market share, since the chances of succeeding are lower and less opportunities are left. Additionally, firms using their internal capital to fund investments are less monitored by capital markets (Harford and Uysel, 2014). Thus, these firms are probably less able to gain market share. Moreover, cash-rich might use their cash holdings to pay off debt to avoid financial distress costs (Almeida et al., 2009). Finally, cash-rich firms might not use their accumulated cash abroad, because of repatriation taxes (Pinkowitz et al., 2012). Therefore, when confronted with limited access to external capital, cash-rich firms might not use their cash holdings to fund investment opportunities. Hence, they may not be able to gain a larger market share compared to cash-poor firms.
The existing literature regarding the investment policy suggests that financially constrained firms cut their investments more than less constrained firms and that the firm’s investment policy is adjusted because of financial constraints (Almeida et al., 2009; Campello et al., 2010; Duchin et al., 2009). This indicates that cash-rich firms are probably more able to stick to their initial investment policy than firms with lower cash holdings. When firms undertake all valuable investment opportunities, the opportunities to increase their market share are larger compared to firms adjusting their investments because of financial constraints. In addition, Haushalter et al. (2007) and
25 Hoberg et al. (2014) find that market considerations and threats affect firm’s policy to accumulate cash, which indicates the importance of cash holdings as a strategic position in the market. Hence, as Fresard (2010) suggests, precautionary behavior leads to real benefits. To investigate the implications of cash holdings in the market competition, this research tests the following hypothesis:
Hypothesis 1: Cash-rich firms which are subject to limited access to external capital are able to
increase their market share during a financial crisis relatively more than cash-poor firms facing similar external financial constraints.
To gain more insight into the potential benefits of large cash holdings, the main research model is subject to some variations. Three other outcomes are analyzed in order to investigate the benefits of high cash levels. One of the alternatives includes market dominance instead of market share. The model incorporating market dominance analyzes not just whether a cash-rich firm is able to increase their market share relatively more, but whether the firm is specifically able to control an industry in a certain geographic area like the state of the firm’s headquarter. Market dominance is different than market share, as it takes the influences of customers, suppliers, competitors in the geographic area and state level government regulations into account. This analysis and its expectations are in line with the main hypothesis and corresponds to the following hypothesis:
Hypothesis 2A: Cash-rich firms which are subject to limited access to external capital are able to
increase their market dominance during a financial crisis relatively more than cash-poor firms facing similar financial constraints.
Another outcome which is analyzed is the return on assets (ROA) with respect to the industry average. The outcome focuses on the quality of the firm’s assets and analyzes the differences in asset quality in relation to the cash. This analysis answers the question whether cash-rich firms are able to undertake more qualified investments because of the larger internal capital or whether cash-poor firms anticipate the smaller internal capital and therefore are forced to develop alternatives to derive higher returns on their investments. Fresard (2010) also analyzes the effect of higher cash levels on ROA and find that cash-rich firms experience increases in ROA, compared to their cash-poor rivals. Therefore, his finding corresponds to the following hypothesis:
Hypothesis 2B: Cash-rich firms which are subject to limited access to external capital are able to
increase their return on assets during a financial crisis relatively more than cash-poor firms facing similar external financial constraints.
