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

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 cashflows 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.

Trade credit in China: Exploring the link between short term debt and payables

“…However, as suggested by Kling (2018), cash holdings are not the only factor affecting firm's capability to access further short-term credit: those firms that perform better have a propensity to apply for cheaper bank debt (Biais and Gollier, 1997;Petersen and Rajan, 1997) and are more likely to be successful in applying for bank finance (Baas and Schrooten, 2006;Berger and Udell, 2006). In fact, small, young and opaque firms typically struggle to access bank finance (Berger and Udell, 2006;Boissay and Gropp, 2007;Howorth and Reber, 2003): when they are young they lack a long and established history that proves that they are successful and they are not able to exploit a consolidated social capital (Ferrary, 2003;Howorth and Moro, 2006).…”

“…In fact, not all the cash available to the firm is used to cover the financial needs linked to the cash conversion cycle. Kling (2018) proposes a theory of operational cash holding based on the cash conversion cycle (Gitman, 1974;Richards and Laughlin, 1980). His model suggests that firms do not cover short-term needs entirely by using the cash available but rely on short-term bank debt and on suppliers' finance.…”

“…Cash holdings, in turn, reduce insolvency risk, enhancing access to short-term finance so that they also have an indirect effect on firms' capability to access alternative sources of short-term finance (Belghitar and Khan, 2013;Kling et al, 2014). All in all, not only are cash holdings retained for operational needs but also are kept to address unexpected shocks and facilitate credit access (Kling, 2018;Lins et al, 2010). Past research also suggests that a longer cash conversion cycle is associated with smaller liquid reserves (Deloof, 2001;Kim et al, 1998) and that there is a positive relationship between cash holdings and payables but a negative one between cash holdings and receivables (Wu et al, 2012).…”

“…Our research builds on the existing literature on the use of credit from suppliers (Deloof, 2003;Deloof and Jegers, 1996;Kling, 2018;Psillaki and Eleftheriou, 2015) by exploring the relationship between trade credit and bank credit. In particular, we examine whether SMEs tend to follow a complementarity or substitution logic in financing their working capital needs in the context of Chinese SMEs, a context where typically buyers are granted discounts when they pay immediately.…”

“…Following Kling (2018), we explore firms' financing decisions by using a framework where the change in sales determines additional working capital needs (change in stock and change in receivables) that in turn affect the additional use of bank debt and payables. To explore the substitution/complementarity between bank and supplier credit, we focus on the link between payables and bank debt, since in the case of a substitution (complementarity) effect we should find a negative (positive) relationship between these two variables.…”