Financial crisis and corporate cash holdings: evidence from East Asian firms Youngjoo Lee (Univ. at Buffalo) and Kyojik “Roy” Song (SKKU)

Research motivation  Since the global financial crisis over the period of , many researchers have investigated the short-term changes in cash holdings. - Duchin et al. (2009) find that financially constrained firms decrease investments following the onset of crisis. - Campello et al. (2009) find that financially constrained firms draw down their cash reserves to cope with the financial crisis.  Commentators’ concerns about large cash holdings of Asian firms - Korean companies have been warned that they face possible difficulties in competing against chief international corporations in the future, due to their overly conservative management styles, according to Bank of Korea’s “Business Achievements of Major Corporations by Industries” report  What is the long-term effect of Asian financial crisis on cash holdings? Do they fundamentally change the management policies?  What factors lead to the increases in the firms’ cash holdings?

Literature Review 1. Transactional motive of cash holdings – A firm can save transaction costs by using cash to make a payments without having to liquidating assets. - Miller and Orr (1966) - Mulligan (1997): large firms hold less cash

Literature review continued 2. The precautionary motive – firms tend to hold cash to cope with future adverse shocks when access to capital markets is costly. - Kim et al.’s (1998) and Opler et al.’s (1999) models: the optimal amount of cash holdings is determined by a trade-off. - Almeida et al.’s (2004) cash flow sensitivity of cash (the propensity to save cash out of cash flow): financially constrained firms display positive cash-cash flow sensitivity. Their model also implies that financially constrained firms’ cash flow sensitivity increases after exogenous shocks. - Han and Qiu (2007) find that financially constrained firms increase their cash holdings in response to increases in cash flow volatility.

Literature review continued 3. The agency motive - Dittmar et al. (2003): firms in countries with poor shareholder protection hold more cash. - Harford et al. (2007): firms with weaker corporate governance dissipate their cash reserves more quickly and the firms sped the cash primarily on acquisitions.

Literature review continued 4. The tax motive - Foley et al. (2007) find that multinational firms that face higher repatriation tax burdens hold higher levels of cash and hold this cash abroad.

Hypotheses  East Asian firms experienced unprecedented exogenous shocks during the Asian financial crisis of The precautionary motive of cash holdings implies that firms would increase cash holdings after exogenous shocks.  Are the increases in cash holdings related to changes in investment, payout, or capital raising?  Testable hypotheses: - Firms’ sensitivity to cash flow risk might increase after the crisis. - Increases of the firms’ cash holdings might be explained by changes in firm characteristics.

Data  We collect data on 32,174 firm-years representing about 5,059 industrial firms over the period of from Worldscope and Datastream.  The sample firms are incorporated in eight East Asian Countries, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand.

Cash holdings of U.S. firms (Bates et al., 2006)

Cash ratios of firms in eight East Asian countries

How have they built the cash holdings over time?  Run simultaneous equations on cash ratios and investments.  We look at the effect of investments on cash holdings and the effect of cash holdings on investments.

Regression results Whole sample period ( ) Before the crisis ( ) After the crisis ( ) Cash ratio Investments/ assets Cash ratio Investments/ Assets Cash ratio Investments/ Assets Intercept (<0.01) (0.07) (0.36) (0.05) (<0.01) (0.04) NWC/assets (<0.01) (0.05) (<0.01) Investments/assets (<0.01) (0.22) (<0.01) EBIT/assets (<0.01) (0.09) (0.03) (0.14) (<0.01) (0.09) Market-to-book ratio (<0.01) (<0.01) (0.35) (0.66) (<0.01) (<0.01) Firm size (0.17) (0.12) (<0.01) Leverage (<0.01) (0.37) (<0.01) Dividend dummy (<0.01) (0.38) (<0.01) Industry sigma (0.33) (0.50) (0.35) Cash ratio (<0.01) (0.03) (<0.01) Sales growth (<0.01) (<0.01) (<0.01) Year dummyYes Firm dummyYes Adj. R N

Pre-existing firms, IPO firms during, after the crisis

Firm characteristics before vs. after the crisis

Predicting cash ratios using Fama- MacBeth method Cash ratio = Industry Sigma Market-to-book ratio Firm size EBIT/asset – NWC/assets – Capex/assets Leverage Dividend Proceeds from stock sales Increase in total debt.

Predicted vs. actual cash ratios

Does changes in sensitivity to cash flow risk explain the increase in cash holdings?

The effect of financial constraints on changes in cash holdings  The literature on precautionary motive of cash holdings suggests that financially constrained firms increase their cash ratios more than unconstrained firms after the macroeconomics shocks [for instance, Opler et al. (1999), Han and Qiu (2007), and Almeida et al. (2004)].  We classify the pre-existing firms into financially constrained firms and unconstrained firms using firm size, dividend payment, and leverage, following Alti (2003).

Financially unconstrained vs. constrained

Variable Financially constrained firms Unconstrained firms Estimates Interaction Post-crisis dummy Estimates Interaction Post-crisis dummy Intercept (<0.01) (0.75) (<0.01) (<0.01) NWC/assets (<0.01) (<0.01) (<0.01) (0.98) Investments/assets (<0.01) (0.19) (<0.01) (0.07) EBIT/assets (<0.01) (0.10) (<0.01) (0.43) Market-to-book ratio (<0.01) (0.88) (<0.01) (<0.01) Firm size (0.38) (0.65) (<0.01) (<0.01) Leverage (<0.01) (0.79) (<0.01) (<0.01) Industry sigma (0.25) (0.01) (0.21) (<0.01) Adj. R N3,63110,704

Summary and further research  The firms tend to increase cash holding by reducing investments after the Asian financial crisis regardless of financial constraints.  The firms in Korea, Singapore, Hong Kong, and Taiwan have increased cash holdings more than those in other countries.  The increase in cash holdings is not explained by changes in firm characteristics after the crisis.  The increase in firm’s sensitivity to cash flow risk explains some of the changes in cash holdings.  These findings are partially consistent with the precautionary motive of cash holdings.