Journal of Asset Management and Financing (Dec 2024)
Impact of COVID-19 on Corporate Cash Holdings and Speed of Adjustment
Abstract
Cash management is critical for firm value as both cash surpluses and deficits can diminish value. Consequently, firms aim to maintain optimal cash levels by adjusting their actual cash ratios towards target ratios. Various factors influence cash holdings and the speed of these adjustments. This study examined the impact of the COVID-19 pandemic, which had heightened the precautionary motive for firms to hold cash. The analysis used observations from 159 firms from 2008 to 2022, applying Generalized Least Squares (GLS) regression and the system Generalized Method of Moments (system-GMM) while controlling for industry and year effects. The results indicated that during the COVID-19 period, firms' cash holdings ratios became increased than doubled and the speed of cash ratio adjustment increased by nearly 40% compared to previous years. These findings are consistent with the predictions of pecking order and trade-off theories, extending the existing literature by highlighting the pandemic's role in intensifying firms' financial pressures. The results suggested that the increased cash adjustment speed represented a strategic response to avoid the financial consequences of the COVID-19 crisis.Keywords: Precautionary Motive, Speed of Adjustment, COVID-19, Trade-off Theory, Cash Holding.JEL classification codes: G31, G32 IntroductionCash management is a critical aspect of firm liquidity and performance. The precautionary motive is considered the primary driver for holding cash as it becomes more important when firms face greater cash flow uncertainty or limited access to external financing during crises (Opler et al., 1999; Almeida et al., 2004). Global crises, such as the COVID-19 pandemic, can lead to heightened financing constraints for firms (Zubair et al., 2020). Based on pecking order theory, firms are expected to increase their cash holdings to preserve investment opportunities during such periods of crisis. Additionally, the trade-off theory suggests that the uncertainty induced by global crises may increase adjustment costs, leading to slower cash holdings adjustments. However, the benefits of moving more quickly towards target cash levels could potentially outweigh the higher adjustment costs, resulting in faster cash holdings adjustments (Melgarejo & Stephen, 2023). To investigate the impact of the COVID-19 pandemic on corporate cash holdings and their adjustment dynamics in Iran, this study examined the following hypotheses:H1: Compared to other years, firms held higher cash balances during the COVID-19 pandemic.H2: Compared to other years, the speed of cash holdings adjustments was higher during the COVID-19 pandemic. Materials & MethodsThis study utilized data from 159 firms (2,226 firm-years) in Iran for the period of 2008-2022. The data were primarily collected from the Rahvard Nowin database and any missing information was supplemented using reports published on the Codal website. For the analysis, the study period was divided into two sub-periods: the pre-COVID-19 period (2008-2018, 1,749 firm-years) and the COVID-19 pandemic period (2019-2021, 477 firm-years). The COVID-19 pandemic was considered to have started in the winter of 2018, affecting the financial reporting of that year, and continued through the end of 2021. To test the research hypotheses, the study employed a two-pronged approach. First, the static models were estimated using the Generalized Least Squares (GLS) estimator to examine the first hypothesis regarding the impact of COVID-19 on firms' cash holdings levels. Second, the dynamic models were estimated using the Blundell and Bond’s (1998) system Generalized Method of Moments (system-GMM) estimator to measure the speed of cash holdings adjustments and test the second hypothesis. To address potential statistical issues, the standard errors of the coefficients in the static models were corrected using cluster-robust standard errors at the firm level. For the dynamic models, the standard errors were corrected using Windmeijer’s approach (2005). Additionally, the study conducted robustness tests by considering the years 2020-2021 (318 firm-years) as the COVID-19 pandemic period and employing the two-stage approach suggested by Orlova and Rao (2018). These additional analyses aimed to ensure the reliability and consistency of the main findings. The data analysis was performed using Stata software and tabular data presentations. FindingsThe empirical analysis yielded several key findings. First, the positive and statistically significant coefficient of the COVID-19 dummy variable in the static models indicated that, after controlling for the determinants of cash holdings, as well as year and industry fixed effects, firms held a higher ratio of cash to non-cash assets (4.52-percentage point) during the COVID-19 pandemic period compared to the pre-pandemic years. This supported the first hypothesis that firms increased their cash holdings during the COVID-19 crisis. The dynamic model results provided further insights. Prior to the COVID-19 outbreak, the estimated speed of cash holdings adjustment was around 50%, suggesting that firms removed half of the deviation from their target cash ratio over a 12-month period. However, during the COVID-19 pandemic, the speed of adjustment increased to approximately 68.5%, implying that firms removed half of the deviation from their target cash ratio in about 7 months. These findings suggested that the speed of cash holdings adjustments increased by around 40% during the COVID-19 period compared to the pre-pandemic years and this was in line with the second research hypothesis. Overall, the results demonstrated that firms in Iran increased their cash holdings and exhibited faster cash holdings adjustments in response to the heightened uncertainty and financing constraints imposed by the COVID-19 crisis. These findings are consistent with the predictions of the pecking order and trade-off theories, highlighting the importance of precautionary cash management during periods of global economic turmoil. Discussion & Conclusion:The existing literature on the determinants and adjustment dynamics of corporate cash holdings has expanded considerably in recent years. Among the various motivations for holding cash, the precautionary motive has emerged as a key focus of scholarly attention. Theoretical frameworks, such as the trade-off theory, have been instrumental in explaining firms' cash management behaviors. Prior studies have investigated the impacts of firm-level, industry-level, and macroeconomic factors on cash holdings and their adjustment speeds. More recently, researchers have examined the effects of global systemic shocks, such as the COVID-19 pandemic, on corporate cash policies. However, evidence from the context of firms listed on the Tehran Stock Exchange (TSE) has been lacking. The current research helped to fill this gap by investigating the impacts of the COVID-19 crisis on the cash holdings and adjustment speeds of Iranian firms. The findings indicated that during the pandemic period, firms' cash-to-non-cash asset ratios increased by 4.52-percentage points compared to the pre-pandemic years. Moreover, the speed of cash holdings adjustments accelerated by around 40% during the COVID-19 crisis, with firms removing half of the deviation from their target cash ratios in about 7 months compared to 12 months in the pre-pandemic period. These results are consistent with the precautionary motive for holding cash and align with the predictions of the pecking order and trade-off theories. The observed increases in cash holdings and adjustment speeds suggested that Iranian firms adopted more aggressive cash management strategies to navigate the heightened uncertainty and financing constraints imposed by the COVID-19 pandemic. The findings of this study contribute to the growing body of literature on corporate cash policies in the context of global systemic shocks. The insights generated may also have practical implications for financial managers in developing economies, highlighting the importance of dynamic and proactive cash management practices during periods of economic turmoil.
Keywords
