Long-Term Effects of a Financial Crisis: Evidence from Cash Holdings of East Asian Firms

Abstract

We investigate the long-term effect of the Asian financial crisis on corporate cash holdings in eight East Asian countries. The median cash to assets ratio for the Asian firms almost doubles from 6.7% in 1996 to 12.1% in 2006, and the sudden increase in cash holdings is pervasive regardless of financial constraints. The Asian firms build up cash holdings by decreasing investment activities such as capital expenditures and acquisitions after the crisis. We find that the increase in cash holdings is not explained by changes in firm characteristics but by change in the firms’ demand function for cash, which indicates that the crisis has systematically changed the firms’ cash holding policies. Specifically, the firms’ increased sensitivity to cash flow volatility is one of the main factors to explain the higher level of their cash holdings in the post-crisis period. These findings are partially consistent with the precautionary motive of cash holdings in that financial crisis can make the management policies of firms very conservative even after the economy recovers from the crisis.

Keywords: Cash holdings, Asian financial crisis, Cash flow risk

JEL Classification: G3, G32