RDP 2016-03: Why Do Companies Hold Cash? 8. Conclusion

Our analysis of corporate cash holdings in Australia indicates that public companies hold more cash than otherwise similar private companies, on average, and their cash holdings are more sensitive to cash flows. These findings suggest that agency costs play some role in determining cash holdings in Australia.

We also find that the trend increase in cash holdings of public companies over recent decades is largely explained by changes in observable company characteristics. In particular, relative to their counterparts of 25 years ago, publicly listed companies today have better investment opportunities (as measured by Tobin's Q) and are more likely to operate in industries with more volatile profits – such as information technology, pharmaceuticals and biotechnology – and these characteristics are correlated with higher levels of corporate cash. After accounting for these factors, our estimates indicate that, by historical standards, corporate cash holdings of Australian publicly listed companies are not unusually high.

Overall, we find that, in the face of financing frictions, some companies have precautionary and speculative motives for holding cash. To the extent that the speculative motive matters, high levels of corporate cash could be taken as evidence that economic conditions are expected to improve in the future, rather than being a sign of perceived weakness in the economy.