What determines the composition of a firm’s total cash reserves?

Finance

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Abstract: We investigate what determines the variation in the composition of the financial assets that make up firms’ total cash reserves. We find that a firm invests a larger fraction of its cash reserves in longer-maturity securities that are less liquid, but earn a higher yield (i) if the firm faces less uncertainty with respect to its short-term liquidity needs or (ii) if it is more difficult for the firm to access external capital markets and most of its cash reserves are held for precautionary purposes to meet its longer-term liquidity needs. We also document evidence that suggests in poorly governed firms managers hold a larger fraction of corporate cash reserves in highly liquid securities that earn a lower yield so they can more easily spend these reserves on self-serving projects. We use several different identification strategies to establish causality of our results. Our findings provide insights on an important component of corporate liquidity management practices.

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