Economic Policy Uncertainty and Cash Holdings of Non-Financial Firms: Exploring the Role of Firm Characteristics

Abstract

Objective: This study sets out to empirically investigate the effects of economic policy uncertainty (ECOPU) on firms’ cash holding decisions (FCHD) in Pakistan for the period 2010-2020. It also explores whether the impacts of ECOPU on FCHD are different for firms having different sizes, facing financial constraints, and owned by the government of Pakistan.

Research Gap: This study bridges the gaps in the existing empirical literature on the association between ECOPU and firm cash holding in two fold. First, it uses the news-based index for measuring ECOPU. This news-based ECOPU index is relatively less utilized in developing countries like Pakistan. Second, the existing studies are silent whether firm-specific variables viz. firm size, ownership structure, and financial constraints have any role in formulating the response of firms to uncertainty while designing cash holding policies: a main theme of the study.

Design/Methodology/Approach: The paper in hand uses the two-step system-GMM estimator to examine the influence of ECOPU on FCHD. This estimator not only yields robust and unbiased estimation results but also controls for potential endogeneity in the dynamic model.

The Main Findings: The results reveal that during the periods of increased ECOPU, Pakistani non-financial firms significantly hold more cash in their reserves. They may do so to effectively handle any financial hindrance in the future. The findings also show that the cash holding decisions of financially constrained (FCON), non-state-owned, and large-sized firms are more responsive to ECOPU as compared to their counterparts.

Theoretical/Practical Implications of the Findings: The findings of this study have numerous important implications for multiple stakeholders that are very useful in decision-making. In this regard, firm managers and investors may take into consideration the different characteristics of firms as well while quantifying the impact of ECOPU on FCHD.

Originality/Value: This research contributes into the literature on several grounds. Firstly, it contributes by examining the effects of the uncertainty associated with macroeconomic policies on cash holdings for an emerging economy, namely Pakistan. Secondly, it adds to the literature by examining the role firm size and financial constraints in establishing the influence of ECOPU on FCHD. Finally, this paper builds on the literature that examines the differential response of stated-owned and non-stated-owned firms to internal and external shocks.