Cash Holdings from a Risk Management Perspective - A study on high investment firms

Abstract: Due to a globalized market place, risk management has grown in importance and become a central part of firms’ corporate strategies. The incentives for engaging in risk reducing activities revolve around reduced agency costs and exploitation of financial advantages. According to the precautionary motive for holding cash, firms must ensure stable and secure access to capital for future investments. This is most prominent for firms with high investment opportunities, and firms who rely on R&D and high capital expenditures to support future operations. Risk management, and hedging in particular, reduces the need for costly external funding, letting firms invest in risky projects. This study is designed to look at whether hedging and cash holdings can be seen as substitutive risk management tools in the manner that hedgers are allowed to hold lower cash reserves. The study also examines if this relationship is strengthened under possible underinvestment problems. With a deductive approach, we investigate the effect hedging has on cash holdings using multivariate regression analysis. Based on this we find evidence that firms with high investment opportunities hold less cash when they hedge. We also find that hedgers lower their cash reserves and therefore we suggest that, from a risk management perspective, hedging and cash holdings can be seen as substitutes.