The effects of capital flows on corporate cash holdings in emerging markets

Using a detailed measure of capital flows and firm level panel data, we test how capital flows
affect corporate cash holdings and how the corresponding change in cash holdings reflect to firm values.
Specifically, we look at whether capital flows increase firms’ dependence on cash during high contagion
risk periods due to elevated macroeconomic uncertainty or reduces firms’ overall reliance on cash by
mitigating the distortions in capital markets. We find that (i) cash holdings are lower in countries that
are more open to capital flows, and (ii) firm values increase in response to reduced cash holdings
following capital liberalization policies. These effects are mainly driven by firms that are dependent on
external financing. Also, although financially dependent firms increase their cash holdings during high
contagion risk periods, the overall impact of capital flows on cash holdings continues to be negative.
Considering debt and equity flows separately indicates a substitutability between debt and cash. As debt
becomes more available or less costly through inflows, corporations reduce cash holdings and firm
values improve as a result. Equity inflows have a negative effect on cash holdings but an insignificant
effect on the marginal value of cash. Overall, these findings suggest that the benefits of capital flows in
extenuating frictions in external markets and thus reducing corporations’ reliance on cash holdings
overcomes its potential costs of increased dependence on cash during high uncertainty periods.