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Time-varying firm cash holding and economic policy uncertainty nexus: a quantile regression approach

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Abstract

This paper examines the time-varying nature of various decisive factors on cash holding decisions. First, we revisit the issue of cash holding determinants of U.S. corporations and argue that firm cash holding predictability is time-varying. To this end, this research proposes a novel empirical framework that builds on the impact of business cycles on firm cash holding’s predictability. Using a three-stage empirical analysis, we also posit that the conventional argument on the EPU-CASH relationship is dependent on the time-varying market structure. Earlier studies have shown that economic policy uncertainty may increase the propensity of cash holding at the firm level. To estimate the theoretical assumption and capture different dynamic relationships, we convert monthly EPU data to annual and develop a cash quantile regression model including several financial characteristics. Employing a large sample of U.S. non-financial firms and non-utilities, we initially estimate 6-year rolling fixed window quantile regressions during the 1970–2016 period. The resulting series of beta estimates are regressed on economic policy uncertainty. The main results confirm the time-varying nature of determinants related to corporate liquidity management. Our findings add a new dimension to the existing literature and therefore be important to the market participants for portfolio allocation in the developed markets. Overall, the new methodology presented in this study contributes to the field of operational research by providing a robust approach to analyze policy uncertainty and its impact on cash management.

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Fig. 1
Fig. 2

Source: Compustat, authors’ calculation

Fig. 3

Source: Authors’ calculation. Source: “Measuring Economic Policy Uncertainty” by Baker et al. (2016) at www.policyuncertainty.com/us_monthly.html, authors’ calculation

Fig. 4
Fig. 5

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Notes

  1. Operational research has dedicated significant attention to developing quantitative models that can help decision makers optimize cash flow and net present value in uncertain business environments (see Peymankar et al., 2021; Wiesemann et al., 2010).

  2. Using the EPU index offers several advantages compared with other uncertainty measures. In particular, the index provides historical information about policy-related economic events, has broader applicability because it covers all major economies, and accurately captures the real effects and patterns of the uncertainty of the global economy (Istiak and Serletis 2018).

  3. This index covers the world’s major economies and has been widely employed by earlier works (e.g., Kim et al., 2024; Yfanti et al., 2023). See the link: https://www.policyuncertainty.com/us_monthly.html. The selected newspapers as sources are (in alphabetical order): Boston Globe, Chicago Tribune, Dallas Morning News, Los Angeles Times Miami Herald, New York Times, San Francisco Chronicle, USA Today, Wall Street Journal, and Washington Post.

  4. The ordinary least squared method minimizes the sum of the squared residuals, while quantile regression method minimizes the sums of absolute deviations. Also, quantile regression analysis weights errors differently depending on whether are within or outside the quantile (Adrian et al., 2019). The quantile regression method is based on conditional distributions. At each specific quantile, the regression estimate measures the marginal impact of the research variable (Xt) on the dependent variable (Yt). Thus, the distribution function is depicted precisely, making it an excellent econometric approach.

  5. Empirical analyses of quantile regression models are obtained using Stata’s “sreg” command.

  6. Due to the economic importance to the global economy (Ahmad et al., 2021), this study focuses on a developed market. Financial turmoil induced by crises may have had a significant impact on profits, investments, and cash holdings. Given that our sample spans several business cycles, we expect that our findings are not sensitive to the financial crisis of 2007/08.

  7. However, as shown in Table S3 of the Online Appendix, the average cash holding ratio for the sample period 1985–2016 (when data for EPU are available) is 0.176, in line with Bates et al. (2018).

  8. The determinants of cash holding are modeled as: Cash-to-total assets = 0.1650 + 0.2271 Leverage – 0.0999 Net working capital/ Assets + 0.0669 Cashflow/Assets – 0.0049 Log size + 0.238 Market-to-book ratio + 0.0360 R&D/Sales – 0.3651 Capital expenditures/Assets – 0.4141 Acquisitions/Assets + 0.1784 Net debt + 0.1930 Net equity + 0.0012 Loss dummy + 0.3399 Industry cash flow risk – 0.0264 Dividend dummy.

  9. The time-varying nature (stability) of cash holdings’ determinants is reported in detail in Online Appendix.

  10. Table S2 in Online Appendix presents the results of the rolling window quantile regression model regarding the effects of firm-specific variables on corporate cash holdings.

  11. In addition to the baseline application, we re-estimate the baseline model of Eq. 1, including the natural logarithm of EPU (LEPU). In line with the precautionary motive, we expect that the EPU index positively affects the cash ratio. Table S4 in Online Appendix reflects underlying results from the ordinary least squares (OLS) and quantile regressions. Results demonstrate that the estimate on LEPU is positive and significant at the 1% level (β = 0.0151, t-stat = 5.19), suggesting that a higher EPU drives firms to hold more cash to a higher cash ratio. In economic terms, a one standard deviation increase of the economic policy uncertainty index (LEPU) results in about a 2% increase in cash ratio [(st.dev. LEPU x coeff. LEPU)/mean CASH] × 100 = [(0.233 × 0.015)/ 0.176] × 100 = 2%]. Consistent with prior findings (e.g., Duong et al., 2020; Phan et al., 2019), firms retain more cash to maintain a sufficient level of internal funds, in high uncertainty era.

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Acknowledgements

We would like to express our sincere gratitude to the Editor-in-Chief, Professor Endre Boros, and an anonymous reviewer for their support and invaluable suggestions, which have greatly contributed to the improvement of this paper.

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Authors and Affiliations

  1. Department of Accounting and Finance, Hellenic Mediterranean University, Heraklion, Greece

    Christos Floros

  2. Department of Accounting and Finance, Bang College of Business, KIMEP University, Almaty, Kazakhstan

    Emilios Galariotis

  3. Department of Economics, University of Patras, 26504, Rio, Patras, Greece

    Efstathios Magerakis

  4. Financial Engineering Laboratory, School of Production Engineering and Management, University Campus, Technical University of Crete, 73100, Chania, Greece

    Constantin Zopounidis

  5. Department of Management Science and Technology, University of Patras Megalou Aleksandrou 1, Koukouli, 26334, Patras, Greece

    Konstantinos Gkillas

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Floros, C., Galariotis, E., Gkillas, K. et al. Time-varying firm cash holding and economic policy uncertainty nexus: a quantile regression approach. Ann Oper Res 341, 859–895 (2024). https://doi.org/10.1007/s10479-024-06176-1

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