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Recent liquidity studies attempt to explain corporate liquidity from new perspectives. For example, diversification has been found to play a role in determining the value of cash holdings. This is because agency problems are more severe in diversified firms such that cash is less valuable under such circumstance (Tong 2011). Another kind of liquidity research looks into the relationship between country-specific variables and corporate liquidity. For instance, country-specific proxies for investor protection as constructed by La Porta et al. and other governance ratings have been widely used in multi-country liquidity studies (Doidge et al. 2007). The predominance of these country-specific governance-related variables over firm-specific counterparts in explaining corporate liquidity has been well documented (Dittmar et al., 2003; Kalcheva & Lins 2007). This is expected because firms operate in a larger environment characterised by country-specific factors; thus, the financial decisions of firms should be affected by these larger concepts. further
Corporate liquidity is related to macroeconomic conditions. For example, in anticipation of better future economic conditions, a firm’s managers are inclined to hold more cash to take advantage of greater investment opportunities when such time arrives (Kim et al. 1998). In addition, when economic uncertainty is higher, firms are inclined to hold more cash as a precaution. Such cash hoarding is likely to prevail among firms because they generally fail to predict accurately their financial conditions; hence, they choose to build up cash reserves unanimously under such circumstances (Baum et al 2006, 2008). Furthermore, interest and inflation rates play a role in determining corporate liquidity, although the results are weak (Garcia Teruel and Martinez Solano 2008; Natke 2001). Chen and Mahajan further find that other country-specific/macroeconomic variables, such as government deficit, inflation, credit spread and private credit, also play a role in explaining corporate liquidity. Finally, it has been documented that when inflation is lower and more stabilised, firms can make investments more effectively and reap higher returns because of higher price transparency (Beaudry et al. 2001). This implies that management can consider keeping less cash to make more investments in a low and stabilised inflation regime. In sum, macroeconomic conditions should play a role in determining corporate liquidity because firms are unlikely to isolate themselves from the impact of larger settings.
Despite the good intention of national governments to increase government spending to boost the economy, an increase in government spending and indebtedness creates uncertainty for the economy (Hassan and Strazicich 2000). The purported positive effect of running government deficits on economic growth is likely to be minimal and temporary. In a sense, running government deficits means that governments are borrowing funds from the future for the present use. Eventually, government debt will have to be paid off or reduced through some measures sometime in the future. For example, if government deficit is to be monetised, inflation is expected to increase, and this will erode real purchasing power. Consequently, firms should reduce cash holdings because the real value of cash decreases under such circumstances.