Abstract:
It is quite intuitive that cash holdings would reduce the likelihood of a firm’s inefficient closure. We examine whether and when does this precautionary benefit of cash materialize, using performance-related stock-exchange delisting as a proxy for firm’s premature closure. We find a negative relation between cash holdings and delistings. This relation becomes more pronounced during three exogenous shocks that impose severe liquidity constraints: the early 1990s recession, the dot-com bubble burst, and the global financial crisis. The precautionary benefit is higher for small firms and firms with large current liabilities, especially when they face high idiosyncratic stock-return volatility. Surprisingly, the effect does not show up during Covid pandemic, when the government provided external lifelines. Our study provides a measure of cash’s precautionary benefit, and thus of financial frictions faced by firms. Our measure could identify the circumstances in which a portion of cash holdings must be considered operating asset. This has implications for financial statement analysis, in calculation of working capital, cash flow from operating activities, and free cash flows.