KOREA CAPITAL MARKET INSTITUTE

This report aims to analyze the drivers of the secular increase in cash holdings of Korean companies using fund flow identity from cash flow statement in an effort to determine whether the rise in corporate cash holdings stems from decline in corporate investment or rational corporate financial decision making.

This report contributes to the existing literature in the following ways. First, this report adopts a systematic and integrated approach toward identifying the drivers of the increase in corporate cash holdings, utilizing information contained in the corporate fund flow identity. Second, this report employs Dominance Analysis to identify the independent variable with the highest relative importance defined as average incremental explanatory power for the dependent variable. Third, this report integrates the fund flow identity and a variant of the regression equation for the determinants of corporate cash holdings, to generate a regression equation for the determinants of the change in corporate cash holdings.

The fund flow identity means that cash flow from operations as a source of fund, should be equal to the sum of the change in cash holdings, investments, dividends, share repurchases, net debt redemption, and net equity redemption, all of which are uses of funds. The regression equation for the determinants of the change in corporate cash holdings is composed of the change in cash holdings as the dependent variable, and the five uses of funds other than cash holdings, the first difference of stock independent variables used in the literature on the determinants of corporate cash holdings (i.e., asset, R&D, leverage, net working capital, ROA, and sector average cash flow volatility), firm age, and asset tangibility, as independent variables.

The results of empirical analyses including the Dominance Analysis on the determinants of the change in corporate cash holdings are provided below. First, the fund flow variables altogether explain 33% of the change in corporate cash holdings whereas the first difference of the determinants of corporate cash holdings explains the majority. Second, investment exhibits the largest relative importance for the change in corporate cash holding since 2014. In a similar vein, the absolute value of the regression coefficients on the investment has been increasing since 2011. Third, when the sample is separated into positive and negative cash flows from operations, investment has had the dominant explanatory power for the change in corporate cash holdings over the whole sample period.

The analysis results have the following implications. First, the recent increase in corporate cash holdings in Korea has been driven by decreasing corporate sector investment. Second, government policy should focus on how to boost corporate investment, the driver of the increase in corporate cash holdings, rather than trying to suppress cash holdings. Third, financial intermediaries should strengthen M&A and corporate restructuring advisory services in an environment where corporate demand for capital raising dwindles.