Peer Effects on Corporate Cash Holdings

Yiwen Chen Yuanchen Chang

Department of FinanceNational Chengchi University

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Motivation of this studies

•U.S. companies are sitting on an enormous and growing pile of cash.

•Cash reserve plays an important strategic role.

•This paper offers a new perspective to examine cash holdings.

Introduction

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Figure I: U.S. companies are sitting on an enormous and growing pile of cash.

Introduction

Why do U.S. firms hold so much more cash than they used to? (BKS, 2009 JF)

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Demand function for cash holdings

• If left unmonitored, entrenched managers may waste free cash flows (Jenson, 1986)

•Deep pockets argument (Fresard, 2010 JF).•Smooth R&D expenditures (Brown and Petersen,

2011, and Shin and Kim, 2011).

•→ Cash reserve plays an important strategic role like a preemptive weapon !

Introduction

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Hypothesis

•Firm tend to mimic the cash holding decisions of their industry counterparts.

•Firms that are financially constrained and have higher R&D expenditures exhibit more pronounced cash mimicking tendencies.

Introduction

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Empirical findings

•The ratio of cash to total assets is significantly influenced by peer firms’ average cash holdings.

•The peer firm effect on cash holdings is not only directly through channel of peer firms’ cash holdings, but also indirectly through their competitors' characteristics.

•Firms that are financially constrained and have higher

R&D expenditures tend to mimic cash holdings of their rivals.

Introduction

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Contributions

•Prior studies do not consider the peer firm effects on cash holding and thus under-estimate the need for it.

•Imitation is a common form of behavior that arises in a variety of business domains, we recognizes the interactions among firms.

Introduction

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Data

• Sample:▫manufacturing firms (SIC code: 2000-3999): because firms

with high cash holdings concentrate in this sector as shown in Figure I.

•Data source: ▫annual accounting data from Compustat database▫monthly returns from CRSP▫portfolio returns from Ken French’s website

• Period:▫ from 1980 to 2011

Data and Summary Statistic

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Baseline Regression

• where the indices i, j, and t correspond to firm, industry, and year, respectively.

•y: cash and short-term investment divided by book asset•X: 1.market-to-book ratio of assets 2.log of asset size

3.cash flow to assets 4.net working capital to assets

5.capital expenditures to assets 6.leverage ratio

7.dividend payout dummy 8.payout ratio

9.R&D to sales 10.acquisitions to assets

Refer to Bates, Kahle, and Stulz (2009) and others (Table I)

Methodology and variable construction

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Endogeneity (simultaneity) issues

• If firms’ cash holding decisions are influenced by one another, then it can be argued either that causes or that causes .

•Solution:▫Instrument variable (TSLT)

Methodology and variable construction

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Instrumental Variable

Methodology and variable construction

•A valid instrumental variable must satisfy the relevance and exclusion conditions.

• Instrumental Variable: lagged idiosyncratic stock returns of peer firms (PIDIO-ijt)(Following Leary and Roberts, 2012)

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Instrumental Variable Calculation

Methodology and variable construction

Estimate coefficients (4-factor model)

Compute expected returns

Annual actual return – annual expected return

The industry average excluding the i observation

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Table VI: Cash Holding Regression

Results

Panel A. Coefficient estimation results of cash holding regression　Model OLS TSLS

(1) (2) (3) (4) (5) (6)

Peer Firm AverageCash to Total Assets 0.6987 *** 0.7451 *** 0.6117 *** 0.4447 *** 0.6116 *** 0.4457 ***

(0.0130) (0.0208) (0.0153) (0.0372) (0.0419) (0.1324)

Firm Size 0.0114 *** 0.0129 *** 0.0130 ***

(0.0015) (0.0023) (0.0044)

Dividend Payout Dummy -0.0225 * -0.0858 *** -0.0858 *

(0.0118) (0.0182) (0.0448)

R&D to Sales 0.0001 0.0014 *** 0.0014 **

(0.0003) (0.0001) (0.0006)

Acquisitions to Assets -0.0327 -0.4116 *** -0.4105 ***

      (0.0631)       (0.0993)       (0.1162)  

N 18794   18495   12872   12858   12883   12869  

R2 0.3198   0.3186   0.2684   0.2764   0.2535   0.2657  

Industry Fixed Effects YES   YES   NO   NO   YES   YES  

Year Fixed Effect YES　 YES　 NO　 NO　 YES　 YES　

14Table VI: Cash Holding Regression

Results

Panel B. First stage regressionCons 0.4600 *** 0.4604 ***

(0.0040) (0.0233) Peer Firm Equity Shock 0.0002 *** 0.0003 *

(0.0001) (0.0001) Market-to-Book 0.0003 *** 0.0003

(0.0001) (0.0003) Firm Size -0.0216 *** -0.0218 ***

(0.0008) (0.0038) Capital Expenditures to Assets -0.9428 *** -0.9215 ***

(0.0376) (0.1744) Dividend Payout Dummy -0.2957 *** -0.2951 ***

(0.0063) (0.0227) R&D to Sales 0.0031 *** 0.0031 ***

(0.0000) (0.0006) Acquisitions to Assets -0.8006 *** -0.8099 ***

(0.0422) (0.1406) R2 0.6733 　 0.6758　Durbin-Wu-Hausman (DWH) Test 37.9738   3.0090  Industry Fixed Effects NO   YES  Year Fixed Effect NO　 YES　

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Table VII: Cash Holding Regression of High/Low R&D Expenditure Subsample

Results

Panel A. High/Low R&D Expenditure Subsample  

Model OLS 2LSL  Subsample high R&D low R&D high R&D low R&D high R&D low R&D high R&D low R&D  Peer Firm Average

Cash to Total Assets 1.0348 *** 0.4597 *** 1.0415 *** 0.4976 *** 0.9555 *** 0.4143 *** 0.6980 *** 0.2733 ***

(0.0267) (0.0148) (0.0403) (0.0228) (0.0646) (0.0288) (0.1861) (0.0842)

Panel B. High R&D Expenditure Dummy

Model OLS 2LSPeer Firm Average

Cash to Total Assets 0.4841 *** 0.5121 *** 0.4578 *** 0.2470 *

(0.0134) (0.0209) (0.0393) (0.1276)

Cash to Total Assets*D(high R&D) 0.5443 *** 0.5420 *** 0.4854 *** 0.4841 ***

(0.0142) (0.0142) (0.0189) (0.0189)

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Table VIII: Cash Holding Regression of High/Low Sale Subsample

Results

Panel A. High/Low Sale Subsample  Model OLS 2LSLSubsample high Sale low Sale high Sale low Sale high Sale low Sale high Sale low SalePeer Firm Average

Cash to Total Assets 0.3338 *** 0.9853 *** 0.3667 *** 0.9018 *** 0.3093 *** 0.9462 *** 0.2889 *** 0.4234 ***

(0.0180) (0.0312) (0.0303) (0.0422) (0.0286) (0.0836) (0.0778) (0.1484)

Panel B. High Sale Dummy  

Model OLS 2LSLPeer Firm Average

Cash to Total Assets 0.9229 *** 0.9166 *** 0.7997 *** 0.5720 ***

(0.0247) (0.0280) (0.0606) (0.1367)

Cash to Total Assets*D(high Sale) -0.2835 *** -0.2795 *** -0.2055 *** -0.1909 ***

(0.0248) (0.0264) (0.0289) (0.0299)

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•When managers make their decisions on cash holdings, they will take the average of industry cash holdings into consideration.

•The peer firm effect on cash holdings is not only directly through channel of peer firms’ cash holdings, but also indirectly through their competitors' characteristics.

•Firms with higher R&D expenditure or more financial constraints exhibit more pronounced mimicking tendencies.

Conclusion

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Thanks!