Why Do Firms Hold Cash? Evidence from Demographic Demand Shifts

Abstract

We exploit variation in demand induced by demographics to provide causal evidence of the precautionary motive of cash holdings. Specifically, we show that firms significantly increase their cash levels in response to exogenous increases in investment opportunities. We also present the dynamics of accumulation and use of cash in response to changes in forecasted demand. Financially constrained firms build their cash reserves using internal sources. Consequently, they start saving earlier and keep high cash levels longer. Unconstrained firms rely on external financing both to invest and build cash reserves, allowing them to save less and incur lower costs of carry.

Keywords: Cash Holdings, Payout, Precautionary Motive

JEL Classification: G30, G32, G35