Corporate Cash Holdings and Tax‐induced Debt Financing

Abstract

Stockpiling of liquid assets in cash decreases the possibility of a firm's falling into financial distress and becoming technically insolvent. Such stockpiling provides incentives for firms to increase their leverage because cash holdings decrease potential financial distress costs and increase target debt‐equity ratios. This paper examines whether firms' excessive cash holdings enhance an explanatory power of the marginal tax rate for the change in leverage. The results show that high‐taxed firms with excess cash are more likely to increase their leverage. The increase in leverage is not to discipline the entrenched managers' discretionary use of free cash, and the excess cash is not simply for planned future investments either. We also find that the results still hold even when the financial crisis periods are excluded and that the debt financing behavior changes with the level of statutory tax rate. These findings provide evidence that firms with sufficient cash are more likely to take advantage of interest tax shields.

Liquidity-Profitability Tradeoff Existence in Turkey: An Empirical Investigation Under Structural Equation Modeling

“…As discussed in Kling et al (2014), cash holdings increase the ability of firms to cover possible operating loses emerged especially by liquidity shocks and to reach current liabilities in better conditions as an alternative of financing current assets, for example suppliers are more willing to provide trade credit to firms with higher liquidity positions. Also, as discussed in Jung and Kim (2008) study, stockpiling of liquid assets provides incentives for firms to increase their leverage because cash holdings decrease potential financial distress costs and increase target debt-equity ratios. In this sense, firms in Turkey decrease financial risks on cash conversion cycles by applying P-WCM and increase operating efficiency by gaining ability and flexibility on managing current liabilities.…”

Peer Group Effect in Firm Cash Holding Policy: Evidence from Korean Manufacturing Firms

“…Market leverage (LEVER) is defined as the ratio of total debt to the sum of total debt and market value of equity (e.g., Leary and Roberts, ). Firm size (Size) is the natural logarithm of total assets (e.g., Ozkan and Ozkan, ; D'Mello et al ., ; Jung and Kim, ; Joh and Kim, ). The bank debt rate (BANKD) is measured as the ratio of total bank loans to total debt (e.g., Ozkan and Ozkan, ; Jung and Kim, ).…”

“…Trade‐off theory contends that the optimal level of cash in the firm is determined by the marginal benefit and cost of cash holding (Ferreira and Vilela, ; Jung and Kim, ). Holding enough cash allows firms to avoid transaction interference due to a cash shortage; as a result, firms can save on transaction costs (Keynes, ).…”

“…Financial deficit is operating income, after interest and taxes, minus the cash dividend, net investment, and increase in net working capital, including the change in long‐term debt to current assets (e.g., Frank and Goyal, ; Byoun, ). The market‐to‐book ratio (MTB) is the sum of total liability on the ledger and market value of equity over the book value of assets (e.g., Ozkan and Ozkan, ; Jung and Kim, ; Joh and Kim, ; Leary and Roberts, ). Market leverage (LEVER) is defined as the ratio of total debt to the sum of total debt and market value of equity (e.g., Leary and Roberts, ).…”

How do Chinese firms adjust their financial leverage: an empirical investigation using multiple GMM models

“…This greatly reduces the agency costs of free cash flow. While analyzing financing decisions in Korean firms, Jung and Kim (2008) reported that firms having larger cash reserves have better chance of exploiting benefits of interest tax shield in Korea.…”