The Dynamics of Cash

Abstract

Little is known about how firms manage cash policy over time. This paper fills this gap by examining if and how firms manage cash toward a target cash ratio. Estimating partial adjustment models of cash, we find that firms actively adjust their cash toward a target; however, the speed of adjustment is slow and there is large dispersion in the speed of adjustment across firms. We investigate the causes for this and find evidence consistent with the presence of adjustment costs. We also examine the implications of these results for previous interpretations of cross-sectional results. To do this, we simulate firms’ cash paths allowing for costly adjustment and find that the emerging patterns question the interpretation of some of the standard results in the empirical cash literature