Cash Policies and Firm Size

94 Pages Posted: 20 Apr 2022 Last revised: 7 May 2024

See all articles by Ali Kakhbod

Ali Kakhbod

University of California, Berkeley

A. Max Reppen

Boston University - Questrom School of Business

Tarik Umar

Rice University

Hao Xing

Boston University - Questrom School of Business

Date Written: November 7, 2023

Abstract

How does a firm manage its cash reserve as it grows? A firm's policy for cash holdings balances the motives for investment and precautionary savings. The relative importance of these motives changes as a firm's size changes. This mechanism helps explain patterns in cash holdings, equity issuances, and firm size. Specifically, examining a sample of 11.5 million firms, we present a new empirical fact: Within a firm, the level of cash holdings (equity issuance) is U-shaped in firm size. To rationalize this finding, we develop and estimate a continuous-time model of firm dynamics with decreasing return to scale and costly financing. Cash levels are U-shaped in firm size within a firm because of the interplay of the investment and precautionary savings incentives. When a firm is small, cash levels decrease with size because the firm uses cash to grow, capitalizing on better investment opportunities. As the firm grows, investing slows and cash levels eventually increase to prepare for larger-scale cash flow shocks. Overall, firms tailor their cash management policies to their size.

Keywords: Cash holdings, liquidity management, costly financing

JEL Classification: E22, G30, G31, G35

Suggested Citation

Kakhbod, Ali and Reppen, Anders and Umar, Tarik and Xing, Hao, Cash Policies and Firm Size (November 7, 2023). Available at SSRN: https://ssrn.com/abstract=4079159 or http://dx.doi.org/10.2139/ssrn.4079159

Ali Kakhbod (Contact Author)

University of California, Berkeley ( email )

Haas School of Business
2220 Piedmont Ave
Berkeley, CA 94720
United States

Anders Reppen

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

Tarik Umar

Rice University ( email )

Houston, TX
United States

HOME PAGE: http://https://business.rice.edu/person/tarik-umar

Hao Xing

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

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