All You Need is Cash: Corporate Cash Holdings and Investment after the Financial Crisis

Abstract

This paper studies how cash holdings at the onset of the global financial crisis afffected the investment behavior of SMEs after the shock. We use balance sheet data for a large sample of UK SMEs and introduce a novel identification strategy exploiting the volatility of cash holdings to reduce endogeneity concerns. We find that cash holdings are a key determinant of investment by SMEs not only during the crisis but also during the recovery period. Cash-rich SMEs could maintain their capital stock during the global financial crisis, while cash-poor rivals reduced theirs. This gave cash-rich SMEs an advantage when the economy rebounded, resulting in a persistent investment gap which grew over the seven years following the shock. The amplification effect was particularly pronounced for younger

and smaller firms and in industries where credit conditions tightened more. Competition dynamics and borrowing constraints seem to drive this amplification effect.

Keywords: cash holdings, credit constraints, financial crisis, Firm Investment

JEL Classification: E22, E32, E44, G32