Competition, peer firm effects, and cash composition

Abstract

We examine the relationship between competition and the composition of corporate cash. A precautionary motive might suggest firms increase the less risky pure cash component when the threat of competition increases. Using fluidity as a measure of competition and exploiting a change in import tariffs as an exogenous shock, we find firms increase the short-term investments component, which is less liquid and more risky. Furthermore, the market's valuation of short-term investments is lower than that of pure cash when competition increases. We posit peer effects as an alternative explanation for this behavior, where firms mimic rivals as a risk management strategy. We identify a causal relationship where firms attempt not only to mimic but also to leap-frog rival firms’ short-term investments. The mimicking of short-term investments is mitigated by stronger external governance. Overall, our findings suggest that competition and peer effects are important determinants of a firm's cash composition.

Department(s)

Finance, Economics and Risk Management

Document Type

Article

DOI

10.1016/j.jbankfin.2024.107092

Keywords

Corporate cash, Peer effects, Product market competition, Short-term investments

Publication Date

3-1-2024

Journal Title

Journal of Banking and Finance

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