Contract Heterogeneity, Operating Shortfalls, and Corporate Cash Holdings

53 Pages Posted: 8 Sep 2009

See all articles by Hao Jiang

Hao Jiang

Erasmus University Rotterdam (EUR)

Woochan Kim

Korea University Business School; European Corporate Governance Institute (ECGI); Asian Institute of Corporate Governance (AICG)

Ramesh K. S. Rao

University of Texas at Austin - Department of Finance

Date Written: September 2009

Abstract

There is anecdotal evidence that the primary reason why managers hold cash on their balance sheets is to cover operating losses (operating shortfalls). In this paper, we rationalize this as an optimal response in a world with contract heterogeneity. Specifically, we relax the standard assumption that all of the firm’s contracts are securities and assume that firms have two kinds of contracts outstanding - securities (issued to providers of financial capital) and non-traded “factor contracts” (issued to the providers of nonfinancial inputs such as labor, leasing companies, providers of processed goods). We derive testable implications and show that over the period of 1980-2007: a) operating shortfalls are an important explanatory factor for corporate cash holdings, b) a firm’s maximum shortfall is a better predictor of cash holdings than average shortfall and c) firms with a high fraction of intangible assets hold more cash in response to operating shortfalls. Also, the secular increase in corporate cash holdings documented by prior researchers appears to be correlated with increasing firms’ operating shortfalls.

Keywords: contract heterogeneity, operating shortfalls, corporate cash holdings

JEL Classification: G30, G32

Suggested Citation

Jiang, Hao and Kim, Woochan and Rao, Ramesh K. S., Contract Heterogeneity, Operating Shortfalls, and Corporate Cash Holdings (September 2009). KDI School of Pub Policy & Management Paper No. 09-09; McCombs Research Paper Series No. FIN-13-09. Available at SSRN: https://ssrn.com/abstract=1469366 or http://dx.doi.org/10.2139/ssrn.1469366

Hao Jiang (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Woochan Kim

Korea University Business School ( email )

LG-POSCO Bldg #524
Anam-Dong, Seongbuk-Ku
Seoul, Seoul 136701
+822-3290-2816 (Phone)
+822-922-7220 (Fax)

HOME PAGE: http://biz.korea.ac.kr/professor/wckim

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Asian Institute of Corporate Governance (AICG) ( email )

1, 5-ga, Anam-dong
Sungbuk-gu
Seoul, 136-701
Korea, Republic of (South Korea)

Ramesh K. S. Rao

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-475-8756 (Phone)
512-471-5073 (Fax)

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