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Cash Holdings, Competition, and Innovation

Published online by Cambridge University Press:  29 December 2016

Evgeny Lyandres  and
Berardino Palazzo
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Abstract

We demonstrate theoretically and empirically that strategic considerations are important in shaping the cash policies of innovative firms. In our model, firms compete in product markets with uncertain structure using cash as a commitment device to invest in innovation. We show that firms’ equilibrium cash holdings are related to the expected intensity of competition. The sign and magnitude of this relation depends on firms’ financial constraints. Consistent with the strategic motive for hoarding cash, we show that firms’ cash holdings are negatively affected by their rivals’ cash-holding choices, even more so when competition is expected to be intense.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 6 , December 2016 , pp. 1823 - 1861
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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