table 3 asymmetric cash sensitivity · asymmetric cash flow sensitivity of cash holding . abstract...

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Asymmetric Cash Flow Sensitivity of Cash Holding

Abstract

Almeida, Campello, and Weisbach (2004) suggest a linear sensitivity relation between cash flow

and cash holding. However, due to differences in investment opportunity and the free cash flow

agency problem, we argue that this sensitivity is asymmetric to cash flow. With a sample of

manufacturing firms from 1988 to 2006, we find that firms with positive cash flow (earnings)

show greater sensitivity than those with negative cash flow, consistent with our prediction.

After dividing our sample into financially constrained and unconstrained firms, we find that

financially constrained firms exhibit a stronger incentive to save cash than unconstrained firms,

but both types of firms exhibit asymmetric cash sensitivity with respect to cash inflow versus

cash outflow.

Key words: cash holding; cash flows; cash sensitivity; financial constraint

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Asymmetric Cash Flow Sensitivity of Cash Holding

1. Introduction

Prior literature has widely studied why firms hold cash and has come up with several

explanations. The precautionary motive suggests that firms use cash holdings to finance new

investments or incoming short-term liabilities when there is an anticipated adverse cash flow

shock. Cash holding, in essence, helps avoid the high cost of external financing in case of cash

shortfall. For example, Bates, Kahle, and Stulz (2009) attribute the increase in cash to the

growing liquidity demand to buffer against cash flow shock.

Almeida, Campello, and Weisbach (2004) develop a model and show that only financially

constrained firms save cash out of cash flow while unconstrained firms do not because

constrained firms have restricted access to external capital markets. They examine the change in

cash holdings on cash flow (called cash flow sensitivity of cash) for a sample of manufacturing

firms and their findings are consistent with their argument. The linear positive relation between

changes in cash holding and cash flow indicates that firms decrease (increase) cash holdings

when they have negative (positive) cash flows. This relation implicitly assumes that the

magnitude of cash holding change is the same regardless of the direction of cash flow. However,

the possibility of cash shortfall varies with the level of cash reserve (Faulkender and Wang,

2006). We argue that cash flow sensitivity is asymmetric to cash flow. In this paper, we

investigate whether firms exhibit asymmetric cash sensitivity when facing positive or negative

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cash flows.

Cash holding enables firms to fund investments and other liabilities to avoid the high cost of

raising funds (Almeida et al., 2004; Acharya, Almeida, and Campello, 2007; Bates, Kahle, and

Stulz, 2009). Riddick and Whited (2009) find that firms with a rise in cash flow tend to turn cash

holdings into investments because the positive cash flow shock indicates higher productivity of

physical assets. Besides, firms with better investment opportunities and higher market-to-book

ratios tend to hold more cash (Opler, Pinkowitz, Stulz, and Williamson, 1999). In contrast, a

negative cash flow shows the low productivity of existing physical assets, thereby indicating few

new investment opportunities. As a result, when a firm exhibits negative cash flow, it requires

little cash holdings to fund new investments. The difference in investment opportunities results

in an asymmetric response of a cash holding change to positive and negative cash flow.

Aside from the precautionary motive, agency cost between managers and investors also helps

explain the asymmetric cash flow sensitivity of cash holdings. Jensen and Meckling (1976) and

Jensen (1986) show that managers have incentives to over-invest and thus they are likely to hold

some negative NPV projects to maximize their personal benefits. While negative cash flows or

earnings will increase the risk of bankruptcy, managers’ compensation and personal wealth will

suffer only if the firm actually goes bankrupt. Therefore, managers tend to hold a large cash

reserve to help the firm remain solvent (Dittmara, Mahrt-Smith, and Servaes, 2003; Mello,

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Krishnaswami, and Larkin, 2008). Empirically, Bates et al. (2009) show that, compared to

firms with nonnegative income, firms with negative net income have seen a much larger increase

in cash holdings. In other words, even with negative cash flow, managers are unwilling to reduce

the current cash holding. Besides, Faulkender and Wang (2006) find a decreasing marginal value

of cash holdings because the more cash firms hold, the less likely they are to be involved in

external financing, which comes with high transaction costs. Holding the external financing cost

constant, under optimal situations, the cost of reducing the cash reserve by one dollar should be

greater than the cost of keeping the original cash reserve. Therefore, we argue that firms with

positive earnings (a major component of cash flow) exhibit a disproportionately larger magnitude

of cash sensitivity than those with negative earnings.

Using a sample of manufacturing firms from 1988 to 2006, we measure the propensity of firms

to save cash from earnings or operating cash flow. The empirical evidence is consistent with our

prediction: firms with negative earnings or negative operating cash flow are unwilling to take

cash out of their reserves. Following Almeida et al. (2004), we further divide firms into

financially constrained and unconstrained ones based on four criteria: the WW index (Whited

and Wu, 2006), payout ratio, firm size, and bond rating. Financially constrained firms save a

larger amount of cash compared to unconstrained ones. However, both types of firms with

negative cash flow show a smaller magnitude of cash flow sensitivity of cash than those with

positive cash flow. All the results support our hypothesis that firms have incentives that are

asymmetric to the increase or decrease of their cash holdings.

2. Almeida-Campello-Weisbach (ACW) model

We extend the ACW model to incorporate the asymmetric response of a cash holding change to

cash flow as our conceptual foundation. The key components of the ACW model is a firm’s

objective of maximizing the expected lifetime sum of all dividends subject to a set of budget and

financial constraints during periods 0, 1, and 2. Almeida, Campello, and Weisbach (p. 1782,

2004) state their problem as:

s.t. (1) ]d)p1(pdd)p1(pddmax[ L2

H2

L1

H10

C,h,I

0CIBcd 0000

0CIBhcd S1

S1

SS1

S1 for S = H, L

S10

S10

S2 BB)I(g)I(fd for S = H, L

00 qI)1(B

S1

S1 qI)1(B for S = H, L

0h)p1(ph LH

where

dt = the expected dividend at time t

p = the probability of the cash flow at time 1 is high

H, L = the state of the cash flow is high and low

q = a liquidating parameter with a value of q ≤ 1

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τ = a parameter with a value τ < 1

Bt = the debt obligation at time t

It = the firm’s investment at time t, which can be liquidated at time 2

hH , hL = hedging payments in states H and L

ct = cash flow at time t

C = cash holding the firm carries from time 0 until time 1

c1S + hS = the hedging payoff in State S

f(I0) ≡ the total cash flow from I0 investments at time 0 with a value F(I0) + q

I0; F(.) is an increasing, concave, and continuously differentiable

function

g(I1) ≡ a total cash flow from I1 investments in time 1 with a value G(I1) + q I1;

G(.) is an increasing, concave, and continuously differentiable function

The constrained condition of the equation system in (1) is:

qq1

Chcg)p1(

qq1

Chp

)p1(c

pgqq1

ccf

LL1

LH1

0

h,Cmax

L

.

The optimal (2)

condition of Equation (2) is:

*C]c[E

'g*Cc

'f 100 , (3)

where C* is the optimal cash holding; λ = 1 – q + τq; and E0[c1] is the optimal amount of

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hedging given by . The left-hand side of Equation (3) is the marginal cost of

holding cash while the right-hand side of the equation is the marginal benefit of holding cash

under financial constraints. From Equation (3), the cash flow sensitivity of cash is:

)cc(ph L1

H1

L

)I("g)I("f

)I("f

c

*C*1

*0

*0

0

> 0. (4)

The ACW model shows that the cash flow sensitivity of cash is always positive, as shown in

Equation (4), because f’’(.) and g’’(.) are negative and both are concave functions. That is, if

cash flow (c0) is positive, then the optimal cash holding (C*) is also positive or vice versa.

Our extension of the ACW model is as follows. We argue that because of investment

opportunity and agency cost reasons, the magnitude of cash holding responds disproportionately

more to positive than to negative cash flow. Firms experiencing positive (negative) cash flow

have substantially more (fewer) investment opportunities. Specifically, when a firm has

negative cash flow, the resources at its command are rather limited. While the firm is likely to

hold less cash, as the ACW model predicts, it still needs a good amount of cash to weather a

tough operating environment. This suggests that a firm would hold disproportionately more

cash than what is optimal under the ACW model in a negative cash flow environment.

In addition, agency cost consideration suggests that managers hold more than optimal level of

cash to maintain solvency when facing negative cash flow. The agency cost argument implies

that firms continue to hold cash above their optimal level as suggested in Equation (4).

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Therefore, the magnitude of the response of cash holding to negative cash flow is significantly

smaller than that of positive cash flow.

Mathematically, we argue that the functions F(.) and G(.) in the ACW model have two operating

states: one for positive cash flow and one for negative cash flow. Then, the total cash flow

functions in times 0 and 1, i.e., f(I0) and g(I1), are different with respect to positive and negative

cash flow such that Equations (3) and (4) are different in the two operating states. We have:

)I(g)I(f

)I(f

c

*C*1

"*0

''

*0

"

0

> 0 for positive cash flow (5)

)I(g)I(f

)I(f

c

*C*1

"*0

''

*0

"

0

> 0 for negative cash flow, (6)

where “+” stands for a positive cash flow state and “-” stands for a negative cash flow state.

Along with our investment opportunity and agency cost arguments, we have

0c

*C>

0c

*C> 0.

We follow the ACW model and use specific functions for F(.) and G(.) to illustrate our argument.

In Almedia, Campello, and Weisbach (p. 1785, 2004), they state:

F(x) = A ln (x) with A> 0, and

G(y) = B ln (y) with B> 0.

Hence, for optimal cash holding,

1

]c[EcC 100*

,

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where A

B

and the cash flow sensitivity of cash ( ) is given by 0

* c/C

1

, which is

positive.

Let us consider that F(x) and G(y) both have a discontinued point at k* (a point where the cash

flow moves from negative to positive) so that F’(x) and G’(y) are larger above k* than below k*.

Then we have:

F(x) = Aposln (x) if x > k*

= Aneg ln (x) if x ≤ k*; Apos > Aneg > 0.

G(x) = Bposln (y) if y > k*

= Bneg ln (y) if y ≤ k*; Bpos > Bneg > 0.

Accordingly, the cash flow sensitivity of cash is

1, with pos

pos

A

B when the firm has a

positive cash flow. When it has a negative cash flow, the cash flow sensitivity of cash is

1or neg

neg

A

B . By set up, we have δ+ > δ-. Hence, our extension of the ACW model

shows that it is possible to have asymmetric cash flow sensitivity of cash.

3. Methods

Base model

We contend that the magnitude of the response of cash flow to cash holding changes is larger

when there is a positive cash flow than that of a negative cash flow. We use the following

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model to test our hypothesis:

∆Cashholdingsit = α0 + α1Cashflowit + α2Negit + α3Cashflowit * Negit + α4Qit + α5Sizeit +

α6Expenditureit + α7Acquisitionit + α8∆NWCit + α9ShortDebtit-1 + εit, (7)

where

CashHoldings = the ratio of holdings of cash and marketable securities to total asset

ΔCashHoldings = CashHoldings in year t minus the CashHoldings in year t-1

Cashflow = (1) earnings before extraordinary items and depreciation minus

dividend divided by total assets (for Cashflow1); or (2) net cash

flow from operating activities divided by total assets (for

Cashflow2)

Neg = an indicator variable that equals one if the firm has negative cash

flow in that year and zero otherwise

Q = the sum of the market value of equity at the end of the fiscal year

and the value of debt divided by the book value of total assets

Size = the natural log of assets

Expenditure = capital expenditures divided by total assets

Acquisition = an indicator variable that equals one if the firm makes acquisition in

that year and zero otherwise

NWC = noncash working capital (working capital minus cash) divided by

total assets

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ΔNWC = NWC in year t minus NWC in year t-1

ShortDebt = short-term debt divided by total assets

ε = random error term

The empirical model in Equation (7) closely follows the model in Almeida, Campello, and

Weisbach (p. 1788, 2004), with the addition of an indicator variable (Neg) that reveals the

negative cash flows and an interaction term (Cashflow*Neg) to see how cash flow sensitivity

varies with the sign of cash flow. We also include industry and year dummy variables in

Equation (7). Consistent with prior literature, α1 is expected to be positive, indicating a firm’s

incentive to save cash out of cash flow.

In testing the asymmetric cash flow sensitivity of cash, we include the indicator and interaction

terms. We expect to see a negative α3 because firms with negative cash flow are unwilling to take

cash out of their reserves. A significantly negative α3 in Equation (7) would be consistent with

our hypothesis that there is an asymmetric cash flow sensitivity of cash, with the magnitude of

the sensitivity significantly higher for positive cash flow firms than those of negative cash flow

firms.

For other control variables, we include a size variable (Size) to mitigate the economy of scale in

cash saving. The Q (market-to-book) ratio accounts for the future investment opportunity

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because such an opportunity could affect a firm’s incentive to hold cash. Capital expenditure

(Expenditure) and acquisition activity (Acquisition) variables are included because investment

and acquisition reduce a firm’s cash holdings. Net working capital (NWC) works as a substitute

for cash. Thus, we use ΔNWC to control for the effect of net working capital. Short-term debt

at the beginning of the year indicates possible cash outflow during the year, which either draws

out cash or increases managers’ incentive to save more cash. Therefore, we include a ShortDebt

variable in Equation (7).

Financial constraints and asymmetric cash flow sensitivity of cash

Almeida, Campello, and Weisbach (2004) argue that cash holding in unconstrained firms is not

correlated with cash flow because these firms do not face financing constraints. After considering

the asymmetric cash flow sensitivity of cash, we examine how the cash flow sensitivity varies

between financially constrained and unconstrained firms. We use four measures to partition our

sample:

1. We construct an index of a firm’s external financial constraints based on the results in

Whited and Wu (2006). Compared with the common KZ index (Kaplan and Zingales,

1997), Whited and Wu argue that their (WW) index is more consistent with firm

characteristics being related to financing constraints. We first calculate the WW index for

sample firms each year according to the equation below:

WW indexit = -0.091Cashflowit - 0.062DIVPOSit + 0.021TLTDit - 0.044Sizeit +

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0.102ISGit - 0.035SGit,

where

DIVPOS = a dummy variable that equals one if firm i pays out cash

dividend in year t and zero otherwise

TLTD = the ratio of long-term debt to the book value of total assets

ISG = the firm’s three-digit industry sales (data12) growth

SG = a firm’s sales growth

Q = the sum of market value of equity at the end of the fiscal year

and value of debt divided by the book value of total assets

Size = the natural log of assets

Expenditure = capital expenditures divided by total assets

Cashflow, Size, and ε are defined as before. In each fiscal year, we rank firms according to the

WW index. Firms in the top quartile in the annual distribution are considered financially

constrained firms.

2. Dividend payout: If a firm does not pay out a cash dividend in year t, the firm is

assigned to the financially constrained group.

3. We rank firms according to the book value of total assets in each fiscal year; firms in the

bottom quartile of the annual size distribution are considered financially constrained

firms.

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4. We collect data on S&P domestic long-term credit ratings for firms each year; firms that

never have their public debt rated and those with credit ratings below B- are considered

financially constrained firms.

After we partition the sample into financially constrained vis-à-vis non-constrained, we modify

the base model in Equation (7) to study the possible asymmetric cash flow sensitivity of cash.

The modified model is:

∆Cashholdingsit = α0 + α1Cashflowit + α2Negit + α3Cashflowit * Negit + α4Constraintit +

α5Cashflowit * Constraintit + α6Constraintit * Negit + α7Cashlfowit * Constraintit *

Negit + α8Qit + α9Sizeit + α10Expenditureit + α11Acquisitionit + α12∆NWCit +

α13ShortDebtit-1 + εit. (8)

Equation (8) includes the constraint dummy variable (financially constrained firms have a value

of 1) and various interaction variables with cash flow and negative cash flow dummy variables.

We also include industry and year dummy variables in Equation (8). The equation enables us to

see whether the asymmetric cash flow sensitivity still exists after categorizing firms into

financially constrained and unconstrained ones. For unconstrained firms, their cash flow does

not impact cash holdings.

We expect α1 to be positive and α3 to be negative in Equation (8) since the base model should

continue to exhibit a significant level of cash flow sensitivity and an asymmetric cash flow

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sensitivity after controlling for financial constraints. Given the different incentives to hold cash

between the two types of firms, α5 is expected to be positive because financially constrained

firms exhibit stronger cash flow sensitivity of cash than the unconstrained ones. According to our

asymmetric sensitivity of cash flow to cash hypothesis, we expect to see a negative and

significant estimate for α7.

4. Data

Following Almedia, Campello, and Weisbach (2004), we restrict our sample to manufacturing

firms (SICs 2000 to 3999) with available financial data from Compustat. The period is from

1988 to 2006 because cash flow from operating activities, a key variable of interest, is available

only after 1987. All continuous variables are winsorized at the 1% level. Our sample has 41,205

firm-year observations.

Panel A of Table 1 reports the descriptive statistics of the variables in Equation (7). The mean

(median) change in cash holdings (ΔCashHoldings) is -0.07 (-0.001), showing that, on average,

there is only a small change in firms’ cash holdings for the full sample. The mean Cashflow1 for

our sample is -0.011, compared to the median of 0.065, showing that Cashflow1 is left-skewed,

consistent with accounting conservatism. The negative average Cashflow1 may result from the

fact that firms are unwilling to cut dividends even in years with low earnings. The mean (median)

Cashflow2 is 0.015 (0.064), consistent with the fact that firms with positive cash flows are more

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likely to pay out dividends. There is not much difference between the two measures of cash flow.

The mean (median) Q for our sample is 2.081 (1.475), lower than the market-to-book ratio in the

Compustat population. The mean (median) firm size (Size) for our sample is 4.928 (4.707).

Expenditure is right-skewed, with a mean (median) of 0.051 (0.038). The mean (median)

short-term debt (ShortDebt) is 0.051 (0.019). Similar to the situation with Δcashholdings, there is

not much change in the firms’ net working capital, with a mean (median) of -0.006 (-0.002).

About 30% of our sample has conducted an acquisition.

Based on the WW index, Panel B of Table 1 compares the variables between financially

constrained and unconstrained firm-years. With the exception of the change in net working

capital, all other variables are significantly different between the two groups. Consistent with the

definition of the WW index, financially constrained firms are smaller firms with lower

Δcashholdings, Cashflow1, and Cashflow2. Constrained firms also exhibit a higher Q, indicating

more growth and investment opportunities. As expected, firms with liquidity constraints have

lower capital expenditures and higher short-term debt. Compared to unconstrained ones, a

smaller proportion of the constrained firms conduct acquisition activities.

Table 2 reports the Pearson and Spearman correlation coefficients among all variables. While

many correlation coefficients are small, there are a few above 0.3: firm size and cash flow (Size

and CashFlow1 or CashFlow2) and acquisition and firm size (Acquisition and Size). The

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results suggest that larger firms, on average, have larger cash flows and are likely to make

acquisitions.

5. Results and discussions

Table 3 reports the results of the base model in Equation (7). Both Panels A and C in Table 3

show the results of the original ACW model. The coefficients of cash flow (CashFlow1 and

CashFlow2) are positive and significant at the 1% level, suggesting that the cash flow sensitivity

of cash is positive. The findings in Panels A and C are consistent with the results in Almeida et

al. (2004). Given Almeida et al. (2004) use data from 1971 to 2000 and our data cover 1987 to

2006, the general conclusion of a positive cash flow sensitivity of cash is robust to different time

periods and different definitions of cash flow.

Table 3, Panels B and D, report the findings of asymmetric cash flow sensitivity of cash. We

incorporate a dummy variable (Neg = 1 for firms with negative cash flow) as well as an

interaction term with the cash flow variable. Both the dummy variable (Neg) and the

interaction variable (CashFlow*Neg) are negative and significant at the 1% level, suggesting that

negative cash flow firms have a downward drift of cash holdings and their magnitude of

response to a negative cash flow is much smaller than to a positive cash flow. That is, the cash

flow sensitivity of cash is asymmetric; a cash holding responds less to a negative cash flow than

to a positive cash flow. Other control variables show expected signs and are significant at 1%

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level.

Table 4 presents the summary statistics of the four financial constraints under the two definitions

of cash flow. The diagonal in Panel A shows the cross-classification of the constraint types.

As expected, the number of constrained firms and unconstrained firms varies with the different

measures of constraints. If we use WW index, payout ratio, firm size, and bond rating as the

criteria, there are 10,298, 25,120, 10,297, and 32,217 firm-years from financially constrained

firms, respectively. Panel B of Table 4 shows the cash holdings of the financially constrained

vis-à-vis unconstrained firms. The mean of the cash holdings (cash divided by total assets) for

financially constrained firms ranges from 0.217 to 0.266 among the four measures of financial

constraints. For the unconstrained firms, the mean of the cash holdings ranges from 0.092 to

0.173 among the four measures of financial constraints.

Table 5 reports the empirical model of Equation (8) in Panels A and B. We incorporate additional

dummy and interaction variables using different measures of financial constraints (financially

constrained firms have a value of 1) in addition to the negative cash flow dummy variable

(negative cash flow has a value of 1). To examine the asymmetry of cash flow sensitivity of

cash in a financially constrained vis-à-vis unconstrained environment, we pay attention to the

coefficient associated with the interaction variable of CashFlow*Constraint*Neg (showing the

cash holding response of negative cash flow firms with financial constraints). Both panels show

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that the coefficients on CashFlow*Constraint*Neg are negative and significant at the 1% level in

all measures of financial constraints with the exception of the bond rating measure in Panel A of

Table 4, suggesting that financially constrained firms are likely to spend less cash reserve when

they have negative cash flow. The coefficient on CashFlow*Constraint is positive and significant,

suggesting that financially constrained firms, on average, hold more cash when they have

positive cash flow, consistent with the ACW model. In addition, the coefficient on

CashFlow*Neg is negative and significant, suggesting that financially unconstrained firms also

have asymmetric cash flow sensitivity of cash. Other control variables have the expected sign

and they are significant in most of the cases.

Similar to ACW, we further check the results for robustness with different definitions of Q. Table

6 reports the Q using the ratio of future investment to current investment, showing that the key

variables (CashFlow*Constraint*Neg, and CashFlow*Neg, CashFlow*Constraint) continue to

hold the correct sign and many of them are statistically significant.

6. Conclusion

In this paper, we examine whether the cash flow sensitivity of cash holding is asymmetric to cash

flow. Our findings are consistent with our prediction that firms with positive cash flow (earnings)

show greater sensitivity than those with negative cash flow. We further divide firms into

financially constrained and unconstrained firms. Financially constrained firms exhibit stronger

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incentives to save cash than unconstrained firms, but both types of firms exhibit asymmetric cash

sensitivity with respect to cash inflow versus cash outflow.

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References

Acharya, V.V., H. Almeida and M. Campello, 2007, Is cash negative debt? A hedging perspective

on corporate financial policies, Journal of Financial Intermediation 16:515-554. Almeida, H., M. Campello and M.S. Weisbach, 2004, The cash flow sensitivity of cash, Journal

of Finance 59:1777-1804. Bates, T.W., K.M. Kahle and R.M. Stulz, 2009, Why do U.S. firms hold so much more cash than

they used to? Journal of Finance 64: 1985-2021. Dittmara, A., J. Mahrt-Smith and H. Servaes, 2003, International corporate governance and

corporate cash holdings, Journal of Financial and Quantitative Analysis 38: 111-133. Faulkender, M. and R. Wang, 2006, Corporate financial policy and the value of cash, Journal of

Finance 61: 1957-1990. Jensen, M.C., 1986, Agency costs of free cash flow, corporate finance and takeovers, The

American Review 76: 323-329. Jensen, M.C. and W. H. Meckling, 1976, Theory of the firm: Managerial behavior, agency cost

and ownership structure, Journal of Financial Economics 3: 305-360. Mello, R.D., S. Krishnaswami and P.J. Larkin, 2008, Determinants of corporate cash holdings:

Evidence from spin-offs, Journal of Banking and Finance 32: 1209-1220. Opler, T., L. Pinkowitz, R. Stulz and R. Williamson, 1999, The determinants and implications of

corporate cash holdings, Journal of Financial Economics 52: 3-46. Riddick, L.A. and T.M. Whited, 2009, The corporate propensity to save, Journal of Finance 64:

1729-1766. Whited, T.M. and G. Wu, 2006, Financial constraint risk, Review of Financial Studies 19:

531-559.

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Table 1: Descriptive statistics This table reports the descriptive statistics and mean comparison of the variables in testing the asymmetric cash sensitivity between financially constrained and unconstrained firms. CashHoldings is cash divided by total assets; ΔCashHoldings is the CashHoldings in year t minus the CashHoldings in year t-1. CashFlow1 is earnings before extraordinary items and depreciation minus dividend divided by total assets. Cashflow2 is net cash flow from operating activities divided by total assets. Q is market value divided by the book value of total assets. Size is the natural log of assets. Expenditure is capital expenditures divided by total assets. Acquisition is an indicator variable that equals one if the firm makes an acquisition in that year and zero otherwise. NWC is noncash working capital (working capital minus cash) divided by total assets, and ΔNWC is the NWC in year t minus the NWC in year t-1. ShortDebt is short-term debt divided by total assets. Panel A: Descriptive statistics

N Mean Median Std

dev Q1 Q3

ΔCashHoldings 41,205 -0.007 -0.001 0.101 -0.038 0.027

CashFlow1 41,205 -0.011 0.065 0.247 -0.016 0.109

CashFlow2 41,205 0.015 0.064 0.199 -0.018 0.121

Q 41,205 2.081 1.475 1.777 1.081 2.306

Size 41,205 4.928 4.707 2.222 3.289 6.394

Expenditure 41,205 0.051 0.038 0.049 0.020 0.067

Acquisition 41,205 0.295 0.000 0.456 0.000 1.000

ΔNWC 41,205 -0.006 -0.002 0.096 -0.045 0.039

ShortDebt 41,205 0.051 0.019 0.077 0.001 0.066

Panel B: Mean comparison between financially constrained firm-years and unconstrained firm-years

Constrained

firms

Unconstrained

firms Difference t-value

ΔCashHoldings -0.016 -0.004 -0.013*** -9.32

CashFlow1 -0.197 0.051 -0.248 *** -65.47

CashFlow2 -0.144 0.068 -0.212*** -72.11

Q 2.579 1.915 0.663*** 25.99

Size 2.370 5.780 -3.410 *** -249.36

Expenditure 0.041 0.055 -0.013 *** -22.83

Acquisition 0.087 0.364 -0.278*** -71.34

ΔNWC -0.007 -0.006 -0.001 -0.75

ShortDebt t-1 0.067 0.046 0.020*** 19.62

Table 2: Pearson and Spearman correlation This table reports the descriptive statistics and mean comparison of the variables in testing the asymmetric cash sensitivity between financially constrained and

unconstrained firms. CashHoldings is cash divided by total assets; ∆CashHoldings is the CashHoldings in year t minus the CashHoldings in year t-1.

CashFlow1 is earnings before extraordinary items and depreciation minus dividend divided by total assets. Cashflow2 is net cash flow from operating activities

divided by total assets. Q is market value divided by the book value of total assets. Size is the natural log of assets. Expenditure is capital expenditures divided

by total assets. Acquisition is an indicator variable that equals one if the firm makes an acquisition in that year and zero otherwise. NWC is noncash working

capital (working capital minus cash) divided by total assets, and ∆NWC is the NWC in year t minus the NWC in year t-1. ShortDebt is short-term debt divided

by total assets.

ΔCashHoldings CashFlow1 CashFlow2 Q Size Expenditure Acquisition ΔNWC ShortDebt

ΔCashHoldings 0.121 0.278 -0.011 0.061 -0.134 -0.108 -0.244 0.076

CashFlow1 0.130 0.700 0.132 0.282 0.289 0.106 0.142 0.008

CashFlow2 0.236 0.833 0.022 0.369 0.232 0.122 -0.120 0.043

Q -0.008 -0.288 -0.302 -0.011 0.087 0.015 0.041 -0.185

Size 0.058 0.356 0.391 -0.146 0.219 0.361 -0.014 0.027

Expenditure -0.161 0.083 0.082 0.053 0.091 0.033 -0.014 0.033

Acquisition -0.113 0.134 0.150 -0.078 0.350 -0.031 -0.040 0.009

ΔNWC -0.214 0.165 -0.032 0.028 0.009 -0.033 -0.034 0.116

ShortDebt 0.067 0.009 0.035 -0.106 -0.091 -0.058 -0.067 0.172

Left-down side: Pearson; Right-up side: Spearman.

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Table 3: Asymmetric cash sensitivity The models are estimated for a pooled time series and cross-sectional data using the Huber-White procedure with clustering by firms. The sample firms include only manufacturing firms (SICs 2000 to 3999) and the sample period is from 1988 to 2006. CashHoldings is cash divided by total assets; ΔCashHoldings is the CashHoldings in year t minus the CashHoldings in year t-1. CashFlow1 is earnings before extraordinary items and depreciation minus dividend divided by total assets. Cashflow2 is net cash flow from operating activities divided by total assets. Size is the natural log of assets. Q is market value divided by the book value of total assets. Expenditure is capital expenditures divided by total assets. Acquisition is an indicator variable that equals one if the firm makes an acquisition in that year and zero otherwise. NWC is noncash working capital (working capital minus cash) divided by total assets, and ΔNWC is the NWC in year t minus the NWC in year t-1. ShortDebt is short-term debt divided by total assets. ***, **, * indicate significance levels of 0.01, 0.05, and 0.10, respectively. Dependent=ΔCashHoldings

Cashflow1 Cashflow2 Panel A Panel B Panel C Panel D Coef. t-value Coef. t-value Coef. t-value Coef. t-value Intercept -0.0037 -1.29 -0.0111*** -3.72 -0.0005 -0.18 -0.0049* -1.64 CashFlow 0.0866*** 25.17 0.2311*** 20.37 0.1434*** 35.95 0.2440*** 25.84 Neg -0.0062*** -3.49 -0.0050*** -3.06 CashFlow*Neg -0.1836*** -14.21 -0.1498*** -12.82 Q 0.0046*** 10.98 0.0028*** 6.02 0.0052*** 12.06 0.0036*** 7.83 Size 0.0033*** 13.40 0.0033*** 13.60 0.0018*** 7.61 0.0017*** 7.14 Expenditure -0.4021*** -32.33 -0.4368*** -33.63 -0.4068*** -33.11 -0.4262*** -33.95 Acquisition -0.0383*** -33.14 -0.0385*** -33.48 -0.0383*** -33.22 -0.0377*** -32.87 ΔNWC -0.2975*** -33.58 -0.3042*** -34.27 -0.2490*** -30.05 -0.2400*** -29.07

ShortDebt t-1 0.1452*** 21.33 0.1539*** 22.84 0.1239*** 18.73 0.1250*** 19.00

Industry dummy Yes Yes Yes Yes Year dummy Yes Yes Yes Yes N 41,205 41,205 41,205 41,205 R square 0.1570 0.1658 0.1823 0.1889

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Table 4: Financial constraints Panel A reports the firm-year cross-classification for the three criteria used to categorize firm-years as either financially constrained or unconstrained. Panel B displays the summary statistics for cash holdings across groups of financially constrained and unconstrained firms. We assign the letter A for constrained firms and B for unconstrained firms in each row/column. The sample firms include only manufacturing firms (SICs 2000 to 3999) and the sample period is from 1988 to 2006. Panel A: Cross-classification of constraint types

WW index Payout ratio Firm size Bond rating Financial constraint criteria

A B A B A B A B 1. WW index Constrained firms (A) 10,298 Unconstrained firms (B) 30,907 2. Payout ratio Constrained firms (A) 8,748 16,372 25,120 Unconstrained firms (B) 1,550 14,535 16,085 3. Firm size Constrained firms (A) 9,073 1,224 8,685 1,612 10,297 Unconstrained firms (B) 1,225 29,683 16,435 14,473 30,908 4. Bond rating Constrained firms (A) 10,295 22,922 22,920 10,927 10,297 22,920 32,217 Unconstrained firms (B) 3 7,985 2,200 5,788 0 7,988 7,988

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Panel B: Summary statistics of cash holdings

CashHoldings Mean Median Std dev N

1. WW index

Constrained firms (A) 0.266 0.170 0.265 10,298

Unconstrained firms (B) 0.168 0.084 0.203 30,907

p-value(A-B=0) 0.00 0.00

2. Payout ratio



p-value(A-B=0) 0.00 0.00

3. Firm size



p-value(A-B=0) 0.00 0.00

4. Bond rating



p-value(A-B=0) 0.00 0.00

Table 5: Asymmetric cash sensitivity considering financial constraints The models are estimated for a pooled time series and cross-sectional data using the Huber-White procedure with clustering by firms. The sample firms include only manufacturing firms (SICs 2000 to 3999) and the sample period is from 1988 to 2006. CashHoldings is cash divided by total assets; ΔCashHoldings is the CashHoldings in year t minus the CashHoldings in year t-1. CashFlow1 is earnings before extraordinary items and depreciation minus dividend divided by total assets. Cashflow2 is net cash flow from operating activities divided by total assets. Neg is an indicator variable that equals one if CashFlow1 or Cashflow2 is negative and zero otherwise. Constraint is an indicator variable that equals one if the firm in year t is financially constrained and zero otherwise. Q is market value divided by the book value of total assets. Size is the natural log of assets. Expenditure is capital expenditures divided by total assets. Acquisition is an indicator variable that equals one if the firm makes an acquisition in that year and zero otherwise. NWC is noncash working capital (working capital minus cash) divided by total assets, and ΔNWC is the NWC in year t minus the NWC in year t-1. ShortDebt is short-term debt divided by total assets. ***, **, * indicate significance levels of 0.01, 0.05, and 0.10, respectively. Panel A: Using cash flow as earnings before extraordinary items and depreciation minus dividend divided by total assets Dependent=ΔCashHoldings

1.WW index 2. Payout constraint 3. Firm size 4. Bond rating Coef. t-value Coef. t-value Coef. t-value Coef. t-value Intercept -0.0078** -2.31 0.0039 1.47 -0.0075** -2.26 0.0020 0.66 CashFlow1 0.2009*** 16.47 0.1598*** 15.83 0.2008*** 16.56 0.1991*** 11.36 Neg -0.0132*** -5.65 -0.0057** -2.49 -0.0113*** -5.04 -0.0062* -1.95 CashFlow1*Neg -0.1841*** -10.78 -0.1010*** -8.04 -0.1800*** -11.37 -0.1929*** -7.16 Constraint -0.0143*** -4.76 -0.0127*** -13.13 -0.0111*** -3.85 -0.0092*** -5.06 CashFlow1*Constraint 0.1427*** 5.33 0.1435*** 23.30 0.1119*** 4.49 0.0675*** 3.54 Constraint*Neg 0.0198*** 4.74 0.0011 0.42 0.0120*** 2.85 0.0018 0.51 CashFlow1*Constraint*Neg -0.1046*** -3.52 -0.0817*** -8.92 -0.0796*** -2.92 -0.0096 -0.34 Q 0.0030*** 6.48 0.0019*** 5.17 0.0031*** 6.62 0.0009*** 2.64 Size 0.0032*** 10.33 0.0022*** 9.70 0.0031*** 10.03 0.0025*** 9.98 Expenditure -0.4341*** -33.42 -0.4326*** -39.89 -0.4343*** -33.40 -0.4357*** -39.36 Acquisition -0.0387*** -33.64 -0.0321*** -34.69 -0.0385*** -33.51 -0.0320*** -34.47 ΔNWC -0.3049*** -34.36 -0.2810*** -42.16 -0.3044*** -34.34 -0.3242*** -47.73

ShortDebt t-1 0.1541*** 22.76 0.1050*** 20.37 0.1548*** 22.83 0.1274*** 24.14


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Panel B: Using cash flow as cash flow from operating activities divided by total assets Dependent=ΔCashHoldings

1. WW index 2. Payout constraint 3. Firm size 4. Bond rating Coef. t-value Coef. t-value Coef. t-value Coef. t-value Intercept -0.0050 -1.49 -0.0002 -0.07 -0.0008 -0.23 0.0128*** 4.63 CashFlow2 0.2136*** 20.86 0.1653*** 13.15 0.2032*** 19.62 0.1440*** 10.81 Neg -0.0055** -2.56 -0.0018 -0.54 -0.0068*** -3.31 -0.0001 -0.02 CashFlow2*Neg -0.1012*** -5.66 -0.0890*** -4.64 -0.1126*** -7.26 -0.0195 -0.42 Constraint -0.0126*** -5.02 -0.0100*** -5.28 -0.0164*** -6.55 -0.0166*** -9.91 CashFlow2*Constraint 0.1758*** 8.11 0.1323*** 7.57 0.1716*** 8.15 0.1473*** 9.79 Constraint*Neg 0.0108*** 2.93 -0.0011 -0.29 0.0095** 2.54 -0.0055 -1.43 CashFlow2*Constraint*Neg -0.1967*** -7.33 -0.1118*** -4.87 -0.1722*** -6.95 -0.1761*** -3.72 Q 0.0038*** 8.23 0.0037*** 7.93 0.0039*** 8.40 0.0012*** 3.78 Size 0.0022*** 6.94 0.0019*** 7.51 0.0017*** 5.41 0.0008*** 3.59 Expenditure -0.4222*** -33.54 -0.4261*** -34.06 -0.4235*** -33.65 -0.4025*** -41.70 Acquisition -0.0378*** -32.99 -0.0376*** -32.86 -0.0377*** -32.93 -0.0263*** -32.80 ΔNWC -0.2395*** -29.02 -0.2396*** -29.10 -0.2400*** -29.11 -0.2175*** -41.78

ShortDebt t-1 0.1223*** 18.43 0.1226*** 18.70 0.1248*** 18.81 0.0799*** 18.06


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Table 6: Robustness check: Replacing Q with the ratio of future investment to current investment The models are estimated for a pooled time series and cross-sectional data using the Huber-White procedure with clustering by firms. The sample firms include only manufacturing firms (SICs 2000 to 3999) and the sample period is from 1988 to 2006. CashHoldings is cash divided by total assets; ΔCashHoldings is the CashHoldings in year t minus the CashHoldings in year t-1. CashFlow1 is earnings before extraordinary items and depreciation minus dividend divided by total assets. Neg is an indicator variable that equals one if CashFlow1 is negative and zero otherwise. Constraint is an indicator variable that equals one if the firm in year t is financially constrained and zero otherwise. Size is the natural log of assets. Expenditure is capital expenditures divided by total assets. Acquisition is an indicator variable that equals one if the firm makes an acquisition in that year and zero otherwise. NWC is noncash working capital (working capital minus cash) divided by total assets, and ΔNWC is the NWC in year t minus the NWC in year t-1. ShortDebt is short-term debt divided by total assets. Q is the investment in the next two years divided by the current investment. Size is the natural log of assets. ***, **, * indicate significance levels of 0.01, 0.05, and 0.10, respectively.

Dependent=ΔCashHoldings

1. WW index 2. Payout constraint 3. Firm size 4. Bond rating

Coef. t-value Coef. t-value Coef. t-value Coef. t-value

Intercept -0.0096*** -2.95 0.0032 1.11 -0.0103*** -3.17 -0.0036 -1.33

CashFlow1 0.2484*** 21.86 0.1755*** 16.12 0.2477*** 21.61 0.2121*** 12.82

Neg -0.0090*** -3.85 -0.0035 -1.34 -0.0081*** -3.65 0.0023 0.77

CashFlow1*Neg -0.2270*** -13.45 -0.1267*** -8.58 -0.2216*** -14.26 -0.2022*** -7.24

Constraint -0.0142*** -4.52 -0.0135*** -12.04 -0.0122*** -4.04 -0.0064*** -3.84

CashFlow1*Constraint 0.1396*** 4.85 0.1471*** 18.33 0.1226*** 4.71 0.0380** 2.10

Constraint*Neg 0.0164*** 3.80 -0.0007 -0.22 0.0127*** 3.05 -0.0082** -2.45

CashFlow1*Constraint*Neg -0.0958*** -3.00 -0.0858*** -6.78 -0.0828*** -2.87 -0.0051 -0.17

Q 0.0030*** 8.59 0.0028*** 9.50 0.0031*** 8.69 0.0025*** 10.39

Size 0.0033*** 10.55 0.0025*** 9.80 0.0033*** 10.56 0.0021*** 9.42

Expenditure -0.4292*** -32.58 -0.4162*** -33.99 -0.4306*** -32.63 -0.3753*** -37.76

Acquisition -0.0331*** -30.29 -0.0304*** -30.33 -0.0330*** -30.18 -0.0232*** -29.84

ΔNWC -0.3994*** -44.03 -0.3304*** -40.10 -0.3985*** -44.05 -0.3236*** -51.03

ShortDebt t-1 0.1537*** 21.94 0.1180*** 19.47 0.1537*** 21.83 0.1094*** 23.24

Industry dummy Yes Yes Yes Yes

Year dummy Yes Yes Yes Yes

N 30,091 30,091 30,091 30,091 R square 0.2728 0.3111 0.2732 0.3242

table 3 asymmetric cash sensitivity · asymmetric cash flow sensitivity of cash holding . abstract...

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