Cash Holdings; Financing Decisions; and Firm Value: Evidence from India

Abstract

Financing decisions are key to the success of corporates and, cash holdings and debt structure have emerged as reliable financing choices for managers. Although the traditional financial structure revolved around debt-equity decisions, lately cash holdings have emerged as a fundamental financial policy. Both policies are integral to firm’s financial structure and combined they provide firms with a financial flexibility that enables managers to maximize firm value. However, regardless of the recent development of cash holdings among corporates, limited literature exists that explains the characteristics of cash holdings and its role in the valuation aspect of firms. Further, the interrelationship between cash holdings and debt financing structure is missing in recent developments that needs to be explained. In this thesis, we have mainly explored four interrelated empirical studies that relate cash holdings, debt structure, and firm value in the Indian context. While each empirical chapter addresses a specific objective, together, the findings provide the framework of the thesis regarding the firm’s financing choices and the role of cash holdings in aiding managers in handling internal liquidity and risk management. The study undertakes listed manufacturing firms of India for the time period of 2008 to 2021. The first empirical study investigates the factors determining cash holdings with special impetus on debt structure. The findings not only support the classical theories of cash holdings but also bring forth the important determinants explained in light of the theories. The results find evidence of the pecking order theory, trade-off theory, and agency theory in explaining the financial factors that affect cash holding decisions. Besides, the thesis also examines the relationship between debt financing choices and cash holdings. A negative linkage is observed between debt-asset ratio and cash levels. However, debt-cash implications is more attributed to bank debts since borrowings from non-bank sources have a positive effect on cash holdings. The second study explores the impact of macroeconomic indicators on cash holding decisions. Firms are inclined to regulate their financial policies by considering economic risks, and cash holdings serve as reliable sources of financing. Hence, economic indicators are important to gauge the cash holding decisions. The findings indicate that economic risks exhibit a significant effect on cash holdings. The study undertakes three indicators that are relevant to businesses and measures economic uncertainty. The study report that fluctuations in the inflation rate and the exchange rate
exhibit inverse impact on cash holdings. Although, a positive influence is witnessed between interest rates and cash holdings. Later chapters develop on the interrelationships among firm value, cash holdings, and debt structure. The fourth chapter attempts to relate firm value and cash holdings under non-linear conditions and risk management prospects. From the precautionary motive, the study explores the risk aversion and shielding effect of cash during financial distress. The study first documents a positive drive of cash holdigs on firm value. However, the relationship is not static and excess cash devalues the firm. Hence, the study claims that an inverse U-shaped relationship exists between firm value and cash holdings. Further, the study models different scenarios that mark financial crises and economic failures and investigate the role of cash holdings as a risk-hedging instrument. Specifically, the study undertakes the liquidity risks, the great financial recession, and the recent pandemic induced economic crisis to mark different circumstances that led to economic and financial turmoil. The study reports that the cash-value linkage strengthens during recessions. The study also estimates that despite the crisis, the non-linear association is still valid between cash reserves and company’s value. The last empirical chapter ascertains the role of debt financing in determining firm value under heterogeneous beliefs. Specifically, the study investigates the relationship between debt diversification, debt ownership, and firm value. While the classical literature has investigated the relationship between debt and firm value confined to homogeneous debt construction, the objective of the study is to investigate the role of accessing debts from various debt instruments available to firms. The study classifies debt structure as broadly borrowings from either banks or non-bank debt instruments. On the contrary, debt diversification measures the number of independent debt sources from which firms have availed loans. Moreover, the study estimates the relationship for different proxies of measuring firm value, which are ROA, Tobin’s Q, and PE ratio. Debt diversification is found to have a negative and significant impact on firm value for all the measures adopted in the model. The debt asset ratio also reports a negative effect on firm value. However, when constituents of debt are considered, the study finds variations in impact of debt structure on firm value.. While bank debt has a significant positive impact on firm value, non-bank debt borrowings do not exhibit a significant effect on firm value. The empirical findings of the thesis document novel contributions to the existing research. From an academic forefront, the thesis documents the factors influencing the cash holding decisions of firms and validates the appropriateness of various theories in explaining cash holdings. Further, the study explores the relationship between debt structure and cash holdings and explains that debt structure has a lot of consideration in the actual analysis of cash holdings rather than assuming debt as homogeneous. Moreover, the thesis document the impact of changing dynamics of macroeconomic indicators on corporate cash holdings and mark the addition of economic risks as key to cash holding decisions. The thesis also documents the paradigm shift in the role of cash holdings as a mere financing instrument for a firm’s activities to risk management capabilities. From a risk management perspective, the thesis documents the risk hedging prospects of cash holdings regarding their ability to sustain the exposure of the risk and minimize defaults. While the literature has documented the precautionary motive to hold cash, the findings of the thesis contribute to how exactly cash holdings can hedge firms from financial exposures. The thesis also contributes to the recent developments regarding an optimal cash level by exploring the non-linear association between cash holding and firm value. Lastly, the thesis explores the relationship between debt financing and firm value under the context of debt diversification and debt ownership. The thesis establishes the significance of debt structure under heterogeneous beliefs to substantiate how a firm’s reliance on debt financing has gradually incorporated various debt instruments apart from bank borrowings.