Cash Holdings Among Small Businesses

Abstract

I examine the frictions of financial distress, information asymmetry, agency costs, and taxes and the effects they have on observed cash positions of small firms. Firms with higher costs of financial distress, as measured by the amount of research and development conducted by the firm, hold more cash. Firms with greater leverage tend to hold more cash for preventative purposes. Firms perceiving greater information asymmetries when they need money in the future hold more cash relative to firms perceiving a lesser degree of information asymmetry. This is in contrast to firms that have had difficulty in the past raising capital who have lower cash holdings, suggesting that these firms may be operating below their optimal cash position. Older firms carry more cash, even though they should have better access to capital in the future. Cash holdings decrease with size, suggesting economies of scale in the benefits of cash. I also find support for managerial ownership having an effect on cash holdings, but that taxes have no impact.

Keywords: Capital Structure, Cash Holdings, Information Asymmetry, Financial Distress

JEL Classification: G35, G32, G31