ABSTRACT
We examine how economic policy uncertainty (EPU) affects firms’ cash holdings and how such changes in cash holdings affect firm value and capital investment in China. Our findings suggest that firms that increase their cash holdings during high EPU have higher firm values and are less negatively impacted by the underinvestment problem. When a firm is non-state-owned, financially constrained, or is located in a province with low marketization, the impact of EPU on cash holdings is amplified. Furthermore, state-owned enterprises (SOEs) are less likely to increase cash holdings during elevated EPU, and consequently tend to have lower firm values.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
1. While several studies (e.g. Fernandes and Gonenc Citation2016; Xu et al. Citation2016) have examined the impact of cash holdings on firm value, the findings are inconclusive. Thus, China provides a good case study to examine whether the increase in cash holdings during high EPU creates or destroys firm value.
2. Gulen and Ion (Citation2016) find that firms tend to delay firm-level capital investment during high EPU, since long-term investment is irreversible.
3. Tobin’s Q is calculated as the firm’s market value of assets to the book value of assets.
4. In addition to maintaining the short-term operation of the business, a firm needs cash (1) to buffer unexpected negative shocks (Keynes Citation1936; Opler et al. Citation1999), (2) to reduce transaction costs when external financing is expensive (Bates, Kahle, and Stulz Citation2009), (3) to ease financial constraints (Han and Qiu Citation2007), (4) when financial markets are not easily accessible (Song and Lee Citation2012), or (5) when the agency problem is serious (Mikkelson and Partch Citation2003).