The Effect of Stock Liquidity on Cash Holdings: The Repurchase Motive

Abstract

We show that enhanced stock liquidity increases a firm’s propensity to hold cash using tick-size decimalization for identification. Our finding is surprising in light of the view that improved stock liquidity reduces financial constraints. As an explanation, we propose that there is a repurchase motive for holding cash. Higher stock liquidity strengthens this incentive. Consistent with this perspective, we show that firms with more liquid stock increase cash holdings relatively more around the introduction of safe harbor rules for repurchases. With respect to the effect of stock liquidity on cash holdings, therefore, our findings suggest that the repurchase motive dominates the real investments motive. We also show that this effect is not influenced by a firm’s relative ability to access to credit markets.

Keywords: Corporate cash holdings, Stock liquidity, Repurchases, Credit lines

JEL Classification: G32, G35, G10