A theory of operational cash holding, endogenous financial constraints, and credit rationing

Kling, Gerhard

Abstract

This paper develops a theory of operational cash holding. Liquidity shocks due to delayed payments must be financed using cash or short-term debt. Debt holders provide an irrevocable credit line given a firm's expected insolvency risk, and equity holders select optimum cash holding. The model demonstrates the trade-off between cash holding and investing in fixed assets. Introducing uncertain cash-flows leads to precautionary cash holding if debt holders impose financial constraints. Precautionary cash holding, in turn, reduces insolvency risk enhancing access to short-term finance. The theory shows that credit rationing can occur in the absence of market frictions. Using U.S. data from 1998 to 2012, empirical findings suggest that the decline in credit lines has contributed to the increase in cash holding in line with theoretical predictions.

Citation

Kling, G. (2018). A theory of operational cash holding, endogenous financial constraints, and credit rationing. European Journal of Finance, 24(1), 59-75. https://doi.org/10.1080/1351847X.2016.1225590

• Journal Article Type: Article
• Acceptance Date: Aug 1, 2016
• Online Publication Date: Sep 3, 2016
• Publication Date: Jan 1, 2018
• Deposit Date: Aug 31, 2016
• Publicly Available Date: Aug 31, 2016
• Journal: European Journal of Finance
• Print ISSN: 1351-847X
• Electronic ISSN: 1466-4364
• Publisher: Taylor and Francis Group
• Peer Reviewed: Peer Reviewed
• Volume: 24
• Issue: 1
• Pages: 59-75
• DOI: https://doi.org/10.1080/1351847X.2016.1225590
• Additional Information: Additional Information : Accepted version of a forthcoming article to be published in European Journal of Finance published by Taylor & Francis.