Cash, Volatility, and Corporate Investment

• In Event: Financial Accounting and Reporting 6

Abstract

I examine the effect of cash holdings on the relationship between cash flow volatility and corporate investment. My results call into question the long-assumed negative association between cash flow volatility and corporate investment. Using an expanded dataset of U.S. domestic firms, I show that firms with high cash holdings increase investment in the face of increasing cash flow volatility, whereas firms with low cash holdings lower their investment expenditure. In doing so, I provide empirical evidence in support of recent theoretical models predicting that the sensitivity of investment to volatility is dependent on the level of balance sheet cash holdings. I also analyze the mechanism by which cash flow volatility affects investment and show that the relationship between the two is not necessarily driven by how much cash flow volatility a company faces, but rather by how much volatility the company faces after controlling for the ability of balance sheet cash to absorb that volatility.

Author

• Shira Cohen, Columbia University Business School