Do Precautionary Corporate Cash Holdings Help During the Economic Shocks? Evidence from the Covid-19 Pandemic

Abstract

The present study examines the validity of precautionary motive for cash holdings during various phases of the Covid-19 pandemic by establishing a causal relationship between firms’ cash holdings and their abnormal returns. Considering the Covid-19 outbreak as an exogenous event, listed Indian firms’ cumulative abnormal returns regressed on their pre-pandemic cash holdings and relevant firm-level control variables. Results indicate that during the early outbreak period of the pandemic, investors continue to value firms’ growth opportunities over the cash holdings. However, during the lockdown period which had a severe overall negative impact on the firms, firms with higher cash holdings generate significant positive abnormal returns. This supports the precautionary motive behind the cash holdings. During the economic recovery phase, firms with volatile earnings struggle to rebound. The agency cost perspective of cash holdings was found irrelevant during the severe economic crisis. From the risk-management perspective, findings also highlight the difficulty in estimating the optimal cash levels incorporating the black swan events like the Covid-19 pandemic.