International Research Journal of Finance and Economics ISSN 1450-2887 Issue 35 (2010) EuroJournals Publishing, Inc. 2010 http://www.eurojournals.com/finance.

htm

Effects of Macroeconomic Conditions on Corporate LiquidityInternational Evidence

Naiwei Chen Department of Finance, National Chung Cheng University, Taiwan E-mail: finnwc@ccu.edu.tw Tel: +886-5-2720411 ext 34213; Fax: +886-5-2720818 Arvind Mahajan Department of Finance, Texas A&M University, U.S.A Tel: +1-979-845-4876 Abstract The study investigates the effects of macroeconomic conditions on corporate liquidity (cash holdings) in 34 countries from 1994 to 2005. The results show that macroeconomic variables like GDP growth, inflation, real short-term interest rate, government budget deficit, credit spread, private credit, and corporate tax rate have a direct impact on corporate cash holdings. In addition, the study reveals that macro variables have an indirect impact on corporate cash holdings because the effects of firm-specific variables on corporate liquidity can be influenced by macroeconomic conditions. Our study broadens the extant liquidity literature by establishing the role of macro variables, aside from the traditional firm-specific variables, as important determinants of corporate liquidity.

Keywords: Cash Holdings; Corporate Liquidity; Macroeconomic Conditions; Macro Variables JEL Classification Codes: E41, E60, G30, H32

1. Introduction
Cash management is often ignored in normal times. Usually, it is not until a crisis hits that the management of firms realizes the importance of holding cash. Since the US housing market crashed in 2007, a chain reaction has been occurringfrom the insolvency of major financial institutions, job cuts of firms to worldwide economic meltdown. National governments and international financial institutions therefore successively adopted relevant bailout policies or rescue plans to restore the economy at the cost of rising government budget deficit. The current global economy is characterized by economic slowdown, deflation, reduced interest rate, worsening government budget deficit, elevated credit risk, tighter credit, and other economic difficulties. Facing all these changes in macroeconomic conditions, firms should make the necessary adjustments to sustain their businesses. Cash position, one of the major financial decisions, should not be an exception. It is worth exploring how firms should change cash holdings in response to the changes in macroeconomic conditions. Against this backdrop, the current study therefore aims to examine how macroeconomic conditions influence corporate liquidity (cash holdings) in a global environment, an area which has never been explored in extant literature.

International Research Journal of Finance and Economics - Issue 35 (2010)

113

The primary contribution of this study to the existing international corporate liquidity literature is to show that macroeconomic conditions play a crucial role in determining corporate liquidity. The underlying reason is that firms operate in a large macroeconomic environment. Most previous studies use firm-specific financial variables to explain corporate liquidity. Surprisingly, the potential impact of macroeconomic conditions on corporate liquidity has received little attention in extant literature. We therefore attempt to fill this gap. Using comprehensive data from 34 countries spanning the years from 1994 to 2005, our results reveal that macro variables like GDP growth, inflation, real short-term interest rate, government budget deficit, credit spread, private credit, and corporate tax rate indeed directly impact on corporate liquidity. Furthermore, we show that macro variables can affect the sensitivity of corporate liquidity to its benchmark firm-specific determinants. In general, our results establish that along with the conventional firm-specific variables, macroeconomic variables are important determinants of corporate liquidity and should not be ignored in future research.

2. Literature Review
The last decade has seen a burgeoning literature on corporate liquidity (or cash holdings) since Opler et al. (1999) examined the determinants and implications of corporate cash holdings in the US. Early liquidity literature examines which among three theories best explains corporate liquidity. These three theories are the tradeoff theory, the financing hierarchy theory, and the agency theory. The tradeoff theory predicts an optimal corporate liquidity resulting from firms balancing the marginal cost of corporate liquidity and the marginal cost of the shortage of corporate liquidity (Keynes 1936).1 The financing hierarchy theory claims that internal financing is preferred over external financing to fund new investments because of the asymmetric information between managers and investors. Firms accumulate cash and repay debt when they have a surplus of internal funds. When they are short of internal funds, they use cash followed by debt issuance and finally equity to fund new investments. According to this view, corporate liquidity is determined by the changes in internal funds and thus there is no optimal corporate liquidity (Myers and Majluf 1984; Shyam-Sunder and Myers 1999). The agency theory suggests that management tends to hoard cash to gain discretionary power. Hence, there is no optimal corporate liquidity (Jensen 1986). Recent corporate liquidity literature falls into the following three categories: studies using U.S. data (e.g., Kim et al. 1998, Opler et al. 1999, Faulkender 2004, Harford et al. 2008, Bates et al. 2008), single-country studies using non-U.S. data (e.g., Pinkowitz and Williamson 2001, Ozkan and Ozkan 2004, Garca-Teruel and Martnez-Solano 2008), and studies using multi-country data (e.g., Dittmar et al. 2003, Ferreira and Vilela 2004, Pinkowitz et al. 2006, Kalcheva and Lins 2007, Chen and Mahajan 2009). These studies attempt to identify the determinants of corporate liquidity and/or which theory better explains corporate liquidity. Since the three theories predictions on the relationship between corporate liquidity and its determinants (e.g., size, cash flow, investment opportunity set, and other determinants) are not mutually exclusive, it is difficult to provide evidence supporting one theory over the others unambiguously based on the observable sign of the coefficient on some firm-specific variable (Kim et al. 1998; Opler et al. 1999). In spite of the mixed results, the extant literature gives almost irrefutable evidence supporting the presence of optimal corporate liquidity.2 The use of multi-country data to investigate cash holdings is a relatively recent phenomenon. A global vantage point allows for conducting richer tests to explain cash holdings and their value because multi-country data have a wide variation of country-specific characteristics (Pinkowitz et al. 2006; Dittmar and Mahrt-Smith 2007; Kalchiva and Lins 2007). The finance literature on corporate liquidity has largely ignored country-specific macroeconomic factors. However, it is well recognized
1

According to Opler et al. (1999), the marginal cost of corporate liquidity involves the return that could be earned by investing the amount of cash holdings in other assets. The marginal cost of the shortage of corporate liquidity incorporates potential bankruptcy cost. Cash holding and financial distress are negatively related. 2 Refer to the work of Dittmar (2008) for a detailed discussion on optimal corporate liquidity.

114

International Research Journal of Finance and Economics - Issue 35 (2010)

that the economic and political environment in which a firm operates influences its use of factor inputs. The conditions prevailing in the real and financial asset markets in which a firm operates can directly affect the magnitude and volatility of corporate cash flows and cash holdings. Furthermore, the innovations in this environment can affect the fundamental determinants of corporate liquidity as well. This issue remains virtually unexplored in the finance literature. One distinct strand of the macroeconomics literature centers on the scale economy and analyzes the effect of size on corporate money demand. It is found that large firms hold less cash as a percentage of sales than small ones. Besides, the scale elasticity is estimated to be less than one, suggesting the presence of economies of scale in corporate money demand (Mulligan 1997; Bover and Watson 2000). Another kind of literature looks into how macroeconomic conditions affect corporate liquidity. For example, using a panel of U.S. industrial firms, Kim et al. (1998) show that firms hold more cash in anticipation of favorable economic conditions so that they will have enough internal funds when profitable investment opportunities come along. Natke (2001) looks into the corporate liquidity in Brazil and finds that interest rates affect corporate liquidity and that economies of scale exist. Baum et al. (2008) finds that U.S. non-financial firms hold more cash when macroeconomic uncertainty increases. Such studies are few in number and are conducted in a single country setting. This paper aims to fill the gap by examining how corporate liquidity in a large 34-country environment is influenced by macroeconomic conditions such as GDP growth, inflation, real short-term interest rate, government budget deficit, credit spread, private credit, and corporate tax rate. Moreover, the macroeconomicsoriented corporate money demand literature focuses on the total amount of cash held. However, the examination of changes in total cash holdings does not suggest how firms change their asset allocation in response to different macro factors, which is the research focus of our study. In contrast, this study analyzes cash holdings as the percentage of total assets net of cash (net assets). We believe that this scaled cash variable is a more appropriate measure of corporate cash holdings because cash may increase proportionately as total assets increase. Furthermore, while the macroeconomic corporate money demand literature does not consider many firm-specific factors like profitability, net working capital, leverage, dividend paying or non-dividend paying firms, and other factors, these firm-specific variables are used as the control variables in our study. On the other hand, as discussed previously, the strand of liquidity literature in financial economics has largely ignored the macro variables. By incorporating macro variables along with firm-specific variables in our analysis, we therefore attempt to bridge the gap between these two distinct strands of literature.

3. Data
All data for macroeconomic variables (i.e., GDP growth, inflation, short-term interest rate, government budget deficit, credit spread, and private credit) are obtained from International Financial Statistics except corporate tax rate from KPMG's corporate tax Rate Survey. Firm-specific annual financial data are from Worldscope.3 We retrieved data for all non-financial firms from 34 countries.4 The data span 12 years from 1994 to 2005. The raw data obtained from Worldscope were manipulated to obtain empirical variables used in this study (see Table A1 for definitions). A brief description of how these variables were derived follows.
3

The use of this data in international corporate liquidity literature is standard. While accounting differences across countries exist, Worldscope data analysts minimize this by adopting specific procedures. For example, they define each data item in a standard way. To increase comparability, any reported data items different from their definitions are standardized. If there is any variation in formats, Worldscope analysts conform the different formats into their standard industry templates. They also apply other standardization procedures to reconcile various reported data items reported due to different accounting systems, countries, industries and languages (Worldscope Database Data Definitions Guide 2000). We exclude non-financial firms belonging to the division of public administration with 2-digit SIC code ranging from 91 through 99 because they are government-related and their decision criteria may be quite different from the private firms.

International Research Journal of Finance and Economics - Issue 35 (2010)

115

Our key variable is corporate liquidity, which we define as the ratio of cash to net assets, where cash refers to cash plus its equivalents plus marketable securities. Table 1 provides summary statistics of corporate liquidity and its firm-specific determinants in 34 countries analyzed in this study. To be consistent with the observations used in our estimation models, we report the descriptive statistics using only the observations with no missing values for the natural log of corporate liquidity (the dependent variable of the estimation models) and its corresponding firm-specific determinants like market-to-book ratio, size, cash flow, net working capital, capital expenditure, leverage, and dividendpaying firms or not. After applying the above data screening procedures, the remaining sample comprises 36,782 firm-year observations. The weighted average corporate liquidity across 34 countries is 35%, ranging from 9% (Argentina) to 52% (Norway). The medians tell a different story. Singapore has the highest median corporate liquidity (12%) while New Zealand has the lowest (1%). The median for the whole sample is 5%.5 3.1. Firm-specific determinants of corporate liquidity Our selection of firm-specific determinants follows previous research (Table 1). Market-to-book ratio (MTB), a proxy for investment opportunities, is defined as the book value of total assets less the book value of equity plus the market value of equity divided by total assets. Total asset, a proxy for firm size, is in millions of USD. Cash flow (CF), a proxy for firms profitability, is earnings before interest and taxes, depreciation and amortization (EBITDA), less interest, taxes, and common dividends. Net working capital (NWC), an additional liquid asset and a substitute for corporate cash holdings as documented by previous research, is defined as total current assets less cash less total current liabilities. Capital expenditure (CAPX) is additions to fixed assets and serves as the proxy for potential investment opportunities (Kalcheva and Lins 2007). Leverage (LEV), a substitute for cash in terms of financing source, is total debt as a fraction of total assets. Dividend (DIV) is the dummy variable that takes on one if a firm pays dividends and zero otherwise. DIV is used as the corporate governance variable that affects agency costs.6 All firm-specific variables used in this study are ratios except size (the natural log of total assets) and the dummy variable indicating whether firms pay dividends. Following the previous corporate liquidity literature, we calculate the determinants in ratios using net assets as the denominator except for the market-to-book ratio and leverage (Opler et al. 1999, Dittmar et al. 2003, Kalcheva and Lins 2007). Prior to estimation, we winsorize the observations at 1% and 99% levels to remove outliers from the sample. 3.2. Macroeconomic variables Table 2 presents summary statistics of macroeconomic variables used in our study. GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Shortterm rate (ST rate) is the interest rate with a short term-to-maturity. Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. 7 Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit 1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits
5

Our average cash ratios are high and may be considered faulty at first sight. However, it should be noted that the denominator is total assets less cash (net assets), instead of total assets. Our average cash ratio for the US in 2003 is 0.42, which is close to 0.41 as reported for the same year by Dittmar and Mahrt-Smith (2007) that uses the same approach to calculate cash ratios. We originally included closely held shares as another proxy for agency costs in estimation. With this additional variable included, the main results remain unchanged. However, the effective number of observations reduces substantially if this variable is included. Hence, we decided to perform analysis by excluding closely held shares to preserve the sample. Positive (negative) values of government budget deficit indicate that government is running budget deficit (surplus).

116

International Research Journal of Finance and Economics - Issue 35 (2010)

but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's corporate tax Rate Survey.

4. Methodology and Hypothesis Development

4.1. Methodology Since our data are both time-series and cross-sectional, estimation using the panel data model is more appropriate. Among the static panel data models, the fixed-effect model is chosen for our study because the Hausman specification test results suggest that fixed-effect estimators are preferable over the random or between-effect estimators. The following is our fixed-effect panel model specifications:

cashit = + j X ijt + k zikt + uit

j =1 k =1

where cashit indicates the natural log of the ratio of cash to net assets, Xijt denotes the jth firm-specific determinant of corporate liquidity for firm i at time t, and zikt denotes the kth macroeconomic variable for firm i at time t. The error term uit is specified as a two-way error component model:

uit = i + t + it , i = 1,K, N , t = 1,K, Ti where i denotes the unobservable fixed effect for firm i 8,9, t is a time-specific effect for time t, and it is the remainder disturbance for firm i at time t.10
4.2. Hypothesis Development Firms operate in a large country setting, so their financing decisions are affected by macroeconomic conditions. As one of the financing decisions, cash policy should vary with the changes in macro variables in order to sustain businesses. Hence, there is reason to believe that corporate liquidity should also be determined by macroeconomic conditions. For example, management should increase cash holdings if the economy is booming so that it can fund any future profitable investment opportunities resulting from a higher GDP growth. Similarly, management should reduce non-interest-bearing cash in response to higher inflation because holding cash becomes costly. At the same time, firms could also increase interest-bearing cash equivalents because nominal interest rates increase with inflation. Therefore, the net effect of inflation on corporate liquidity is ambiguous, depending which effect is more overwhelming (Natke 2001). If interest rates are rising, management will be better off holding less cash and investing more in assets with higher returns. Government budget deficit might signal a change in future interest rates. If the government budget deficit is higher, the interest rates will be pushed up (Cebula 2005). It follows that with an increase in the opportunity costs of holding cash, corporate cash holdings should decline. An increase in government budget deficit can also signal a decrease in GDP growth, which should decrease corporate liquidity due to the income effect. Based on this reasoning, government budget deficit should have a negative effect on corporate liquidity. Credit
8

Each firm i has its unique number of years Ti because some firms in our sample stopped existing and have unbalanced data. This precludes survivorship bias in our study. 9 Even though the firms that we are interested in come from the same category (i.e., industrial), there are always timeinvariant firm-specific effects because firms are likely to be heterogeneous. We use as many variables as possible to account for the firm-specific nature, but we also introduced a firm-specific dummy variable to capture any remaining firm-specific effects. 10 In estimation, we consider the fact that our data involve many countries and estimate robust standard errors to overcome the problem with clustering in all models.

International Research Journal of Finance and Economics - Issue 35 (2010)

117

spread, a proxy for transaction cost and credit risk, should have a positive effect on corporate cash holdings because firms should hold more cash for the transaction cost motive. Private credit, the borrowing of the private sector from commercial banks and other financial institutions, can also affect corporate cash holdings because there is no need to hoard cash to finance investment projects if the borrowing is deeper. On the other hand, the higher the private credit, the more cash management should probably hold in order to alleviate the concern on financial distress resulting from a higher debt. It follows that the net effect of private credit on corporate liquidity is ambiguous, depending on which effect is relatively stronger. Lastly, although seemingly unrelated, corporate tax should affect firms cash holdings. Understandably, firms should increase debt in response to a higher corporate tax rate because of the tax shield reason. It follows that cash, a substitute for debt, should decline. Hence, there should be a negative relationship between corporate tax rate and cash holdings.11 Based on the reasons cited above, we hypothesize that beyond the benchmark firm-specific factors, macro variables like GDP growth, inflation, short-term interest rate, government budget deficit, credit spread, private credit, and corporate tax rate also affect corporate liquidity. The effects of these macro variables on corporate liquidity have been rarely examined in previous related literature. Of the seven macro variables that we examine in this paper, only GDP growth, inflation, short-term interest rate, and private credit have been considered as potential factors that can affect corporate liquidity in extant literature. However, the results are generally inconclusive (Natke 2001; Dittmar et al. 2003; Kalchiva and Lins 2007; Garca-Teruel and Martnez-Solano 2008). To test this hypothesis, we perform regressions of corporate liquidity on macro variables, controlling for previously identified benchmark firm-specific determinants of corporate liquidity. It is worth noting that the proxy for corporate liquidity in this study, along with other liquidity studies, is cash plus its equivalents plus marketable securities. In other words, cash on the balance sheet also includes interest-bearing liquid assets. The nature of the cash proxy may complicate the liquidity study because one cannot say unambiguously how the non-interest-bearing cash is affected by macro variables. For example, a decrease in pure cash may be accompanied by an increase in interest-bearing liquid assets (e.g., cash equivalents and marketable securities) in response to the rising interest rate. Thus, the net change in corporate liquidity is ambiguous, depending on which one is more affected. Hence, what we can infer from the empirical results at most is whether corporate liquidity can be affected by macro variables, regardless of whether it is interest-bearing or not. With this notion in mind, we conduct two-tailed rather than one-tailed hypothesis tests when examining the effects of the macro variables in this study. Our null hypothesis is that the coefficients on the macro variables are zero against the alternative hypothesis that these coefficients are nonzero. In addition to the direct effects of macro variables on corporate liquidity, the sensitivity of corporate liquidity to its firm-specific determinants can be affected by macro variables as well. For example, GDP growth is expected to reinforce the positive effect of the market-to-book ratio on corporate liquidity because firms should hold more cash to better take advantage of the greater investment opportunities that come along in booms. Government budget deficit, which signals a decrease in future GDP growth and/or an increase in future interest rate, should also inversely affect corporate liquidity through the market-to-book ratio. Similarly, other cash determinants can be affected by macro variables and thus corporate liquidity is indirectly affected. To test this hypothesis, we create interaction variables between the macro variables and the cash determinants to examine whether the corresponding coefficients are zero.

11

These predictions are based on the assumption that cash is narrowly defined as a non- interest-bearing asset. In fact, corporate liquidity in all related papers is measured by cash and marketable securities, the latter being interest-bearing. The reason is that virtually all balance sheets report liquid assets this way. Hardly can we find non-interest-bearing cash separated from interest-bearing marketable securities.

118

International Research Journal of Finance and Economics - Issue 35 (2010)

5. Empirical Results
We obtain the correlation matrix between corporate liquidity and its determinants including the market-to-book ratio, total assets, cash flow, net working capital, capital expenditure, leverage and dividend-paying or non-dividend-paying firms before performing the multivariate analysis.12 We find that corporate liquidity correlates with these determinants, confirming the appropriateness of their inclusion in the estimation. The effects of macro variables on corporate cash holding are examined first. The results are presented in Table 3. Next, we present evidence supporting the idea that macroeconomic variables indeed help explain corporate liquidity. The results are presented in Table 4. We then proceed to examine whether macroeconomic variables affect the sensitivity of corporate liquidity in relation to its major firm-specific determinants; the results are presented in Table 5. 5.1. Effects of Macro Variables on Corporate Liquidity Table 3 presents the fixed-effect panel regression results. Model 1 provides the benchmark without any macro variables included. Models 2 to 5 include four macro variables that are less correlated to mitigate the multicollinearity concern (Table A2). The same applies to models 6 to 9 but with the inclusion of government budget deficit.13 The reason for performing estimations without government budget deficit first is that including it causes a substantial loss of observations due to data insufficiency. Our estimation results on the effects of firm-specific variables are consistent with those obtained by previous studies in terms of the signs associated with the determinants of corporate liquidity. The market-to-book ratio has a positive effect on corporate liquidity with a consistent coefficient of 0.06 throughout all models, suggesting that management holds more cash when facing greater investment opportunities. Size has a positive effect on corporate liquidity, and the coefficient ranges from 0.88 to 0.96 in all models. This suggests the presence of economies of scale, corroborating the findings of previous literature. That is, an increase in total asset by 1% is associated with an increase in corporate liquidity by less than 1%. Cash flow has a positive sign, suggesting that firms tend to accumulate cash from the operating income for precautionary purpose. Net working capital has a negative effect on corporate liquidity, indicating that net working capital and corporate liquidity are substitutes in terms of asset allocation. Capital expenditure, a proxy for growth opportunities, has a positive effect, implying that firms with greater growth opportunities hold more cash. Consistent with previous studies, leverage is negatively related to corporate liquidity, supporting the view that debt and cash are substitutes in terms of financing. Lastly, we do not observe a significant effect of dividendpaying firms on corporate liquidity across all models, suggesting that whether firms pay divided or not plays little role in determining corporate liquidity. More importantly, we show that macroeconomic conditions really matter. Among all macro variables used in this study, GDP growth, inflation, government budget deficit, and corporate tax rate have more consistent impact on corporate liquidity. More precisely, GDP growth has a positive effect on corporate liquidity. This suggests that firms hold more cash in response to higher economic growth, which is consistent with the income effect prediction of the money demand theory. We observe a positive effect of inflation on corporate liquidity. It is counterintuitive at first sight, but we argue that when inflation rises, firms may reduce cash holdings but invest more in cash equivalents and marketable securities, which are also constituents of cash in this study. The increase in holdings of marketable securities may outweigh the decrease in cash such that firms see a net increase in corporate liquidity in response to higher inflation (Natke 2001). Real short-term rate has a negative effect on

12 13

We do not report these results for brevity, but we can provide them upon request. GDP growth and inflation are highly correlated with the correlation coefficient close to 0.8, so we do not include these two variables in the same model. Similarly, we do not include two proxies for private credit at the same time because they are also highly correlated with the correlation coefficient close to 0.7.

International Research Journal of Finance and Economics - Issue 35 (2010)

119

corporate liquidity.14 This suggests that firms reduce cash holdings when the opportunity cost is higher, consistent with the prediction of money demand theory. In models 6 to 9 where government budget deficit is included, we observe a strongly negative impact on corporate liquidity. We argue that higher government budget deficit signals economic slowdown in the future, which could cause firms to hold less cash in anticipation of the reduced investment opportunities that accompany economic slowdown. Credit spread has a positive effect on corporate liquidity. This suggests that when the market is illiquid, firms increase their cash holdings for the transaction cost motive. Alternatively, firms hold more cash when the credit risk is higher, that is, when debt financing is more difficult. Private credit, regardless of its proxies, has a negative effect on corporate liquidity. This suggests that firms reduce corporate liquidity when claims on the private sector by commercial banks and other financial institutions increase. Lastly, although not an apparent determinant of corporate liquidity, corporate tax rate has a negative effect on corporate liquidity. This implies that firms hold less cash when corporate tax rates are higher. We interpret this to mean that debt is a tax shield, suggesting a direct relationship between debt and corporate tax rate. Given that cash and debt are negatively related, this direct relationship between debt and corporate tax rate predicts an inverse relationship between cash and corporate tax rate. Our results on credit spread, private credit, and corporate tax rate suggest that cash and debt are closely related, corroborating the notion that they are substitutes in terms of financing. 5.2. Contribution of Macro Variables to Corporate Liquidity Determination Wald Tests are conducted to examine whether the addition of macro variables significantly adds to the explanatory power of the benchmark model (Table 4), that is, the fixed-effect panel regression of corporate liquidity on market-to-book ratio, size, cash flow, net working capital, capital expenditure, leverage, dividend-paying firms or not as well as year dummies (i.e., model 1 in Table 3). Based on the F-statistics, we strongly reject the hypothesis that the added macro variables have coefficients of zero. This indicates that macro variables indeed provide incremental explanatory power. Overall, the test results for linear restrictions suggest that macroeconomic conditions play an important role in determining corporate liquidity and should not be ignored in corporate liquidity study. 5.3. Effects of Macro Variables on the Sensitivity of Corporate Liquidity to its Firm-Specific Determinants To shed more light on the role of the macro variables in determining corporate liquidity, we further create interaction variables between them and firm-specific variables. Our purpose is to examine the potential impact of macro variables on the sensitivity of corporate liquidity to its firm-specific determinants. Among all macro variables used in this study, we are particularly interested in whether GDP growth and government budget deficit influence the sensitivity of corporate liquidity to the market-to-book ratio, cash flow, and leverage.15 The choice of these two macro variables is because they give strongly significant and persistent effects in estimating the effects of the macro variables as shown in Table 3. Regarding the cash determinants, we choose the market-to-book ratio and cash flow because they are related to the precautionary motive and give strong positive sign in the empirical results. In addition, leverage is chosen because it has been considered negatively related to corporate liquidity as evidenced by previous studies, including the one that we have conducted. The above reasoning makes for three sets of interaction variables (Table 5).

14

15

The original short-term rates are nominal and are highly correlated with inflation, so we use the real short-term rates (i.e., nominal short-term rates adjusted for inflation) for all models to mitigate the multicollinearity problem especially when inflation is included in the estimation. Even though corporate tax rate also has a strong and persistent effect on corporate liquidity, we do not consider it as a potential factor affecting the sensitivity of corporate liquidity because the relationship between corporate tax rate and cash, although statistically significant, is not as intuitive.

120

International Research Journal of Finance and Economics - Issue 35 (2010)

In general, the effects of firm-specific variables on corporate liquidity remain the same after additional interaction variables are included. Focusing on the set of interaction variables for the market-to-book ratio, we find that the one that interacts with GDP growth has a positive effect, suggesting that GDP growth induces management to hoard cash in order to take advantage of the upcoming investment opportunities. That is, the precautionary motive to hold cash is reinforced by economic booms. In contrast, government budget deficit has a negative impact on the sensitivity of corporate liquidity to the market-to-book ratio. This suggests that management hold less cash when government budget deficit rises because they perceive the economy to slow down and thus investment opportunities reduce. As to the interaction variables for cash flow, we continue to observe a positive sign on the variable that interacts with GDP growth. This implies that firms are more inclined to retain cash from cash flow when the economy is booming. In contrast, government budget deficit has negative impact on the sensitivity of corporate liquidity to cash flow. Following the above reasoning, management tends to retain less cash from earnings when the economy is perceived to weaken due to rising government budget deficit. As for leverage, its corresponding variable that interacts with GDP growth is positive, suggesting that cash and debt are less substitutable in booms and conversely, more substitutable during recessions. This makes sense because when accompanied by economic growth, access to the capital market is easier. This reduces the importance of cash holdings for financing. By contrast, a credit crunch prevails in economic downturn, during which cash becomes a more important financing source relative to debt. In addition, the interaction variable between leverage and government budget deficit is negative, suggesting that cash and debt are more substitutable when the government budget deficit is higher. This also makes sense because as discussed above, government budget deficit signals future economic slowdown and tighter credit, which make cash more valuable and more substitutable for debt.

6. Conclusions
This study is the first attempt to examine the effects of macro variables on corporate liquidity in a multi-country setting. Overall, our results show that macro variables play an important role in determining corporate liquidity. The macro variables like GDP growth, inflation, real short-term interest rate, government budget deficit, credit spread, private credit, and corporate tax rate have jointly shown significant impact on corporate liquidity. Among all macro variables used in this study, GDP growth, inflation, government budget deficit, and corporate tax rate exhibit persistently strong effects. More specifically, the positive effect of GDP growth is consistent with the income effect associated with the money demand theory. Firms want to hold more cash when the economy is expanding so that they have enough internal funds to finance profitable investment opportunities in the near future. Inflation is positively associated with corporate liquidity, implying that firms increase cash holdings on net when inflation rises. Consistent with the prediction of the money demand theory, corporate cash holdings are negatively related to the opportunity cost as proxied by real short-term interest rates. Meanwhile, government budget deficit has a negative effect, suggesting that a higher government budget deficit may result in lower GDP growth, which indirectly results in lower corporate liquidity due to the income effect. The positive effect of credit spread suggests that firms hold more cash when credit risk and transaction cost is higher. Private credit has a negative effect on corporate liquidity, implying that firms hold less cash when the borrowing is higher. Lastly, corporate tax rate has a negative effect, suggesting that firms increase debt because of the tax shield reason and then reduce cash holdings which, along with the results on private credit, lend support to the view that cash and debt are substitutes. In addition to the direct impact, macro variables also have indirect impact because they affect the way corporate liquidity is determined by firm-specific factors such as the market-to-book ratio,

International Research Journal of Finance and Economics - Issue 35 (2010)

121

cash flow, and leverage. More precisely, the propensity of firms to hoard cash for future investment opportunities and retain cash from earnings is strengthened in booms and is weakened during recessions. In addition, cash and debt become more substitutable in recessions and less substitutable during booms. In light of the current economy characterized by economic slowdown and rising government budget deficit, our model predicts a weakened precautionary motive for holding cash and increased substitutability between cash and debt. This is consistent with the current real world situation where firms have difficulty hoarding cash because of the reduced cash flow to meet financial obligations. Moreover, internal financing becomes more important because the cost of borrowing becomes higher. To ride out the perfect storm faster, some measures need to be taken to make funds more available in the market so that firms can take advantage of the investment opportunities to come using external debt rather than cash.

Acknowledgement
This work was supported by National Science Council (95-2416-H-126-006), Taiwan. We thank Ekkehart Boehmer, Shane Johnson, Sorin Sorescu and seminar participants at 2008 European Financial Management Association Annual Meeting in Athens, Greece for valuable comments. The usual disclaimer applies.

References
[1] [2] [3] [4] Bates, T., Kahle, K. and Stulz, R., 2008. Why do US firms hold so much more cash than they used to?, Unpublished working paper, University of Arizona. Baum, C. F., Caglayan, M., Stephan, A. and Talavera, O., 2008. Uncertainty determinants of corporate liquidity, Economic Modeling 25, 83349. Bover, O. and Watson, N., 2000. Are there economies of scale in the demand for money by firms? Some panel data estimates. CPER working paper DP2818. Cebula, R. J., 2005. Recent empirical evidence on the impact of the primary budget deficit on nominal longer term treasury note interest rate yields, Global Business and Economics Review 7, 47 - 58. Chen, N. and Mahajan, A., 2009. Euro and corporate liquidity, Unpublished working paper. Dittmar, A. and Mahrt-Smith, J., 2007. Corporate governance and the value of cash holdings, Journal of Financial Economics 83, 599-634. Dittmar, A., Mahrt-Smith, J. and Servaes, H., 2003. International corporate governance and corporate liquidity, Journal of Financial and Quantitative Analysis 38, 111-133. Dittmar, A., 2008. Corporate cash policy and how to manage it with stock repurchases, Journal of Applied Corporate Finance 20, 22-34. Faulkender, M., 2004. Corporate liquidity among small business, Unpublished working paper, Washington University, St. Louis - John M. Olin School of Business. Ferreira, M. A. and Vilela, A. S., 2004. Why do firms hold cash? Evidence from EMU countries, European Financial Management 10, 295-319. Garca-Teruel, P. J. and Martnez-Solano, P., 2008. On the determinants of SME cash holdings: evidence from Spain, Journal of Business Finance & Accounting 35, 127-149. Harford, J., Mansi, S. A. and Maxwell, W. F., 2008. Corporate governance and firm cash holdings, Journal of Financial Economics 87, 535-55. Jensen, M., 1986. Agency costs of free cash flow, corporate finance and takeovers, American Economic Review 76, 323-329. Kalcheva, I. and Lins, K. V., 2007. International evidence on cash holdings and expected managerial agency problems, Review of Financial Studies 20, 1087-1112.

[5] [6] [7] [8] [9] [10] [11] [12] [13] [14]

122 [15] [16] [17] [18] [19] [20] [21] [22] [23]

International Research Journal of Finance and Economics - Issue 35 (2010) Keynes, J. M., 1936. The general theory of employment, Interest and Money, Harcourt Brace and World, New York, NY. Kim, C.-S., Mauer, D. C. and Sherman, A. E., 1998. , Journal of Financial & Quantitative Analysis 33, 335-359. Mulligan, C. B., 1997. Scale economies, the value of time, and the demand for money: longitudinal evidence from firms, Journal of Political Economy 105, 1061-1079. Myers, S. C. and Majluf, N., 1984. Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics 13, 187-221. Natke, P. A., 2001. The firm demand for liquid assets in an inflationary environment, Applied Economics 33, 427-436. Opler, T., Pinkowitz, L., Stulz, R. and Williamson, R., 1999. The determinants and implications of corporate liquidity, Journal of Financial Economics 52, 3-46. Ozkan, A. and Ozkan, N., 2004. Corporate cash holdings: An empirical investigation of U.K. companies, Journal of Banking and Finance 28, 2103-2134. Pinkowitz, L. and Williamson, R., 2001. Bank power and corporate liquidity: evidence from Japan, The Review of Financial Studies 14, 1059-1082. Pinkowitz, L., Stulz, R. and Williamson, R., 2006. Does the contribution of corporate cash holdings and dividends to firm value depend on governance? A cross-country analysis, The Journal of Finance 61, 27252751. Shyam-Sunder, L. and Myers, S. C., 1999. Testing static tradeoff against pecking order models of capital structure, Journal of Financial Economics 51, 219-244. Worldscope Database Data Definitions Guide, 2000. Primark Corporation, Bethesda, MD.

[24] [25]

International Research Journal of Finance and Economics - Issue 35 (2010)

Table 1:
Country Argentina Australia Belgium Brazil Canada Chile Colombia Denmark Finland France Germany Greece Hong Kong India Indonesia Ireland Italy Japan Malaysia Mexico Netherlands New Zealand Norway Peru Philippines Singapore South Africa Sri Lanka Sweden Switzerland Thailand UK US Venezuela Total

123

Cross-country summary statistics of corporate liquidity and its firm-specific determinants, 1994-2005
Cash /net assets 0.09 (0.02) 0.43 (0.05) 0.31 (0.05) 0.35 (0.04) 0.33 (0.02) 0.21 (0.02) 0.28 (0.05) 0.28 (0.05) 0.28 (0.05) 0.33 (0.04) 0.32 (0.03) 0.37 (0.07) 0.42 (0.07) 0.21 (0.02) 0.38 (0.04) 0.43 (0.04) 0.39 (0.05) 0.43 (0.08) 0.29 (0.04) 0.18 (0.02) 0.37 (0.02) 0.19 (0.01) 0.52 (0.08) 0.37 (0.02) 0.26 (0.04) 0.41 (0.12) 0.39 (0.06) 0.30 (0.06) 0.40 (0.06) 0.35 (0.06) 0.28 (0.03) 0.34 (0.02) 0.26 (0.04) 0.12 (0.03) 0.35 (0.05) MTB 1.85 (0.97) 3.10 (1.68) 2.14 (1.37) 1.48 (1.02) 3.16 (1.60) 1.72 (1.07) 1.00 (0.87) 2.10 (1.26) 2.12 (1.56) 2.23 (1.42) 2.24 (1.34) 3.13 (2.08) 2.46 (1.32) 2.07 (1.10) 1.76 (1.11) 2.75 (1.64) 2.17 (1.39) 1.88 (1.14) 1.96 (1.40) 1.61 (1.37) 2.52 (1.69) 2.40 (1.68) 2.31 (1.43) 1.71 (1.19) 1.72 (1.29) 1.82 (1.32) 2.69 (1.60) 1.28 (0.96) 2.92 (1.77) 2.21 (1.31) 1.63 (1.04) 3.07 (1.68) 3.59 (2.22) 0.86 (0.68) 2.40 (1.36) Total assets 950 (183) 66 (8) 628 (173) 906 (319) 257 (33) 635 (180) 550 (311) 426 (75) 676 (97) 784 (72) 576 (96) 208 (101) 179 (63) 261 (114) 129 (47) 262 (123) 1,122 (287) 543 (195) 147 (58) 1,203 (549) 851 (275) 229 (71) 460 (116) 202 (73) 207 (100) 152 (66) 450 (149) 68 (56) 379 (56) 608 (223) 102 (42) 402 (34) 9,041 (4,252) 1,035 (282) 1,107 (114) CF/net assets 0.15 (0.02) 0.01 (-0.01) 0.17 (0.02) 0.22 (0.03) 0.12 (0.00) 0.20 (0.04) 0.28 (0.05) 0.21 (0.03) 0.24 (0.04) 0.20 (0.02) 0.15 (0.02) 0.23 (0.07) 0.08 (0.01) 0.22 (0.05) 0.19 (0.02) 0.30 (0.03) 0.22 (0.02) 0.15 (0.02) 0.15 (0.03) 0.20 (0.03) 0.30 (0.03) 0.34 (0.06) 0.19 (0.03) 0.48 (0.06) 0.13 (0.03) 0.19 (0.05) 0.29 (0.06) 0.31 (0.06) 0.10 (0.01) 0.20 (0.05) 0.19 (0.04) 0.14 (0.01) 0.26 (0.07) 0.22 (0.09) 0.16 (0.02) NWC/net assets -0.06 (0.00) -0.03 (0.00) 0.06 (0.00) -0.12 (-0.01) 0.01 (0.00) 0.06 (0.01) 0.02 (0.01) 0.08 (0.01) 0.09 (0.01) 0.05 (0.00) 0.11 (0.02) 0.13 (0.04) 0.01 (0.00) 0.11 (0.04) 0.07 (0.01) 0.01 (0.00) 0.06 (0.01) -0.01 (0.00) 0.08 (0.02) 0.01 (0.00) 0.07 (0.00) -0.01 (0.01) -0.04 (0.00) -0.02 (0.01) -0.02 (0.00) 0.03 (0.01) 0.01 (0.00) 0.10 (-0.02) 0.08 (0.01) 0.11 (0.03) -0.04 (0.00) -0.03 (0.00) 0.03 (0.01) -0.02 (0.00) 0.02 (0.00) CAPX /net assets 0.04 (0.03) 0.09 (0.03) 0.09 (0.06) 0.07 (0.05) 0.11 (0.05) 0.06 (0.04) 0.05 (0.03) 0.09 (0.06) 0.10 (0.06) 0.07 (0.05) 0.09 (0.06) 0.02 (0.00) 0.06 (0.03) 0.08 (0.05) 0.07 (0.04) 0.09 (0.05) 0.07 (0.04) 0.05 (0.03) 0.06 (0.03) 0.05 (0.04) 0.09 (0.06) 0.06 (0.04) 0.11 (0.06) 0.05 (0.03) 0.06 (0.03) 0.07 (0.03) 0.08 (0.05) 0.06 (0.06) 0.07 (0.04) 0.07 (0.05) 0.07 (0.03) 0.08 (0.04) 0.07 (0.06) 0.05 (0.02) 0.07 (0.04) LEV 0.29 (0.28) 0.13 (0.05) 0.28 (0.27) 0.28 (0.27) 0.18 (0.13) 0.22 (0.21) 0.12 (0.09) 0.25 (0.24) 0.24 (0.23) 0.22 (0.21) 0.21 (0.17) 0.22 (0.22) 0.18 (0.14) 0.28 (0.29) 0.33 (0.32) 0.19 (0.17) 0.24 (0.24) 0.25 (0.23) 0.24 (0.21) 0.23 (0.22) 0.25 (0.24) 0.28 (0.28) 0.31 (0.29) 0.28 (0.27) 0.27 (0.26) 0.22 (0.20) 0.16 (0.14) 0.21 (0.20) 0.16 (0.11) 0.26 (0.25) 0.32 (0.31) 0.16 (0.10) 0.25 (0.24) 0.16 (0.16) 0.22 (0.20) DIV 0.27 (0) 0.21 (0) 0.61 (1) 0.58 (1) 0.15 (0) 0.77 (1) 0.75 (1) 0.66 (1) 0.75 (1) 0.53 (1) 0.44 (0) 0.82 (1) 0.39 (0) 0.78 (1) 0.46 (0) 0.56 (1) 0.60 (1) 0.76 (1) 0.63 (1) 0.36 (0) 0.66 (1) 0.68 (1) 0.39 (0) 0.32 (0) 0.25 (0) 0.61 (1) 0.63 (1) 0.68 (1) 0.41 (0) 0.68 (1) 0.54 (1) 0.48 (0) 0.65 (1) 0.49 (0) 0.56 (1) N 230 2,203 306 578 2,380 453 75 502 411 1,757 1,762 440 1,771 1,431 709 232 659 9,230 769 288 327 120 201 94 230 613 261 34 717 749 894 3,471 2,848 37 36,782

Notes: This table presents mean (median in parentheses) values of corporate liquidity and its firm-specific determinants. Market-to-book ratio (MTB) is defined as the book value of total assets less the book value of equity plus the market value of equity divided by total assets. Total assets are in millions of USD. Cash flow (CF) is earnings before interest and taxes, depreciation and amortization (EBITDA), less interest, taxes, and common dividends. Net working capital (NWC) is defined as total current assets less cash less total current liabilities. Capital expenditure (CAPX) is additions to fixed assets. Leverage (LEV) is total debt as a fraction of total assets. Dividend (DIV) is the dummy variable that takes on one if a firm pays dividends and zero otherwise. All financial ratios are winsorized at the 1% and 99% level. All the firm-specific variables are from Wolrdscope. The mean values for the total sample are weighted averages. N represents the number of observations (firm-years).

124
Table 2:
Country Argentina Australia Belgium Brazil Canada Chile Colombia Denmark Finland France Germany Greece Hong Kong India Indonesia Ireland Italy Japan Malaysia Mexico Netherlands New Zealand Norway Peru Philippines Singapore South Africa Sri Lanka Sweden Switzerland Thailand UK US Venezuela Total

International Research Journal of Finance and Economics - Issue 35 (2010)

Cross-country summary statistics of macroeconomic variables, 1994-2005
GDP 0.09 (0.16) 0.07 (0.07) 0.04 (0.03) 0.12 (0.13) 0.05 (0.05) 0.08 (0.09) 0.12 (0.12) 0.04 (0.03) 0.05 (0.05) 0.04 (0.03) 0.02 (0.02) 0.09 (0.09) 0.00 (-0.02) 0.11 (0.13) 0.18 (0.17) 0.13 (0.12) 0.04 (0.04) 0.00 (0.00) 0.07 (0.08) 0.13 (0.10) 0.05 (0.06) 0.06 (0.06) 0.05 (0.04) 0.05 (0.06) 0.10 (0.09) 0.04 (0.03) 0.11 (0.11) 0.13 (0.14) 0.04 (0.04) 0.02 (0.02) 0.06 (0.06) 0.05 (0.05) 0.05 (0.06) 0.38 (0.24) 0.04 (0.04) Inflation 0.07 (0.04) 0.03 (0.03) 0.02 (0.02) 0.09 (0.07) 0.02 (0.02) 0.03 (0.03) 0.11 (0.08) 0.02 (0.02) 0.02 (0.01) 0.02 (0.02) 0.01 (0.01) 0.04 (0.03) -0.02 (-0.03) 0.05 (0.04) 0.12 (0.12) 0.03 (0.03) 0.03 (0.03) 0.00 (0.00) 0.02 (0.01) 0.09 (0.06) 0.03 (0.03) 0.02 (0.02) 0.02 (0.02) 0.02 (0.02) 0.05 (0.04) 0.01 (0.01) 0.07 (0.06) 0.09 (0.09) 0.02 (0.02) 0.01 (0.01) 0.02 (0.02) 0.02 (0.03) 0.02 (0.02) 0.37 (0.24) 0.02 (0.02) ST rate 0.13 (0.07) 0.05 (0.05) 0.04 (0.03) 0.20 (0.19) 0.04 (0.03) 0.05 (0.04) 0.15 (0.10) 0.04 (0.04) 0.03 (0.03) 0.04 (0.03) 0.03 (0.03) 0.14 (0.14) 0.02 (0.02) 0.09 (0.11) 0.16 (0.14) 0.04 (0.03) 0.04 (0.03) 0.00 (0.00) 0.03 (0.03) 0.15 (0.13) 0.03 (0.03) 0.06 (0.05) 0.06 (0.07) 0.04 (0.02) 0.09 (0.10) 0.01 (0.01) 0.11 (0.11) 0.19 (0.17) 0.04 (0.04) 0.01 (0.01) 0.03 (0.02) 0.05 (0.05) 0.04 (0.05) 0.14 (0.13) 0.04 (0.03) Deficit -0.01 (-0.01) 0.00 (-0.01) -0.02 (-0.02) -0.08 (-0.08) 0.01 (0.01) 0.00 (0.00) -0.05 (-0.05) 0.01 (0.01) -0.03 (-0.02) -0.04 (-0.03) -0.01 (-0.01) -0.07 (-0.08) -0.03 (-0.03) -0.05 (-0.05) -0.01 (-0.01) 0.01 (0.02) -0.04 (-0.02) . (.) -0.01 (-0.02) -0.01 (-0.01) -0.01 (-0.01) 0.01 (0.00) 0.03 (0.03) -0.02 (-0.02) -0.04 (-0.04) 0.04 (0.06) -0.01 (-0.02) -0.08 (-0.08) 0.00 (0.00) 0.00 (-0.01) -0.01 (-0.01) -0.01 (0.00) -0.01 (0.00) -0.01 (-0.02) -0.01 (-0.01) Credit 0.07 (0.05) 0.04 (0.04) 0.04 (0.04) 0.43 (0.43) 0.02 (0.02) 0.04 (0.04) 0.09 (0.10) 0.04 (0.04) 0.02 (0.02) 0.03 (0.03) 0.06 (0.06) 0.06 (0.06) 0.04 (0.04) 0.06 (0.05) 0.04 (0.05) 0.01 (0.01) 0.03 (0.03) 0.02 (0.02) 0.04 (0.04) 0.02 (0.01) 0.06 (0.05) 0.04 (0.05) 0.01 (0.01) 0.19 (0.19) 0.03 (0.03) 0.04 (0.05) 0.04 (0.04) 0.02 (0.02) 0.02 (0.02) 0.03 (0.03) 0.05 (0.05) 0.00 (0.00) 0.03 (0.03) 0.17 (0.17) 0.03 (0.02) Pcredit1 0.17 (0.15) 0.95 (0.99) 0.02 (0.02) 0.31 (0.31) 1.50 (1.70) 0.73 (0.76) 0.30 (0.27) 1.02 (1.35) 0.08 (0.09) 0.12 (0.14) 1.22 (1.23) 0.00 (0.00) 1.50 (1.49) 0.30 (0.29) 0.26 (0.19) 1.23 (1.65) 0.81 (0.82) 1.20 (1.06) 1.31 (1.29) 0.18 (0.18) 0.65 (0.64) 1.16 (1.16) 0.84 (0.86) 0.24 (0.23) 0.41 (0.40) 1.15 (1.14) 1.27 (1.20) 0.29 (0.29) 0.93 (1.02) 1.60 (1.60) 1.10 (1.03) 1.36 (1.36) 1.70 (1.70) 0.12 (0.13) 1.07 (1.06) Pcredit2 0.17 (0.15) 0.95 (0.99) 0.02 (0.02) 0.30 (0.30) 0.42 (0.51) 0.64 (0.64) 0.28 (0.26) 1.02 (1.35) 0.10 (0.10) 0.14 (0.14) 1.22 (1.23) 0.00 (0.00) 1.50 (1.49) 0.30 (0.29) 0.26 (0.19) 1.72 (1.71) 0.81 (0.82) 1.20 (1.06) 1.31 (1.29) 0.17 (0.16) 0.66 (0.66) 1.16 (1.16) 0.73 (0.75) 0.23 (0.23) 0.36 (0.36) 1.09 (1.07) 0.66 (0.68) 0.29 (0.29) 0.81 (1.02) 1.60 (1.60) 1.10 (1.03) 1.36 (1.36) 0.51 (0.51) 0.11 (0.11) 0.92 (1.01) Corp tax 0.35 (0.35) 0.31 (0.30) 0.39 (0.40) 0.34 (0.34) 0.40 (0.39) 0.16 (0.16) 0.35 (0.35) 0.32 (0.32) 0.29 (0.29) 0.36 (0.35) 0.46 (0.40) 0.38 (0.38) 0.16 (0.16) 0.37 (0.36) 0.32 (0.30) 0.24 (0.24) 0.41 (0.40) 0.43 (0.42) 0.28 (0.28) 0.35 (0.35) 0.35 (0.35) 0.33 (0.33) 0.28 (0.28) 0.29 (0.30) 0.32 (0.32) 0.24 (0.25) 0.38 (0.38) 0.35 (0.35) 0.28 (0.28) 0.25 (0.25) 0.30 (0.30) 0.30 (0.30) 0.39 (0.40) 0.34 (0.34) 0.35 (0.36)

Notes: This table presents mean (median in parentheses) values of macroeconomic variables. GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Short-term rate (ST rate) is the interest rate with short term to maturity. Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's Corp tax Rate Survey. The mean values for the total sample are weighted averages.

International Research Journal of Finance and Economics - Issue 35 (2010)

Table 3 Effect of macro variables on corporate liquidity for 34 countries, 1994-2005
1 GDP Inflation Real ST rate Deficit credit Pcredit1 Pcredit2 Corp tax MTB Size CF/net assets NWC/net assets CAPX/net assets LEV DIV Constant N n R2 0.06*** (12.60) 0.93*** (27.96) 0.39*** (12.89) -0.16*** (-4.33) 1.37*** (8.74) -2.01*** (-14.77) 0.05 (1.43) -13.85*** (-28.85) 36,782 11,052 0.12 -0.54 (-1.17) 0.06*** (10.45) 0.95*** (22.71) 0.38*** (10.44) -0.18*** (-4.05) 1.41*** (7.41) -2.10*** (-12.87) 0.00 (0.03) -14.18*** (-23.87) 29,969 9,508 0.11 1.16** (2.48) 0.02 (0.44) 1.12** (2.37) 0.78 (1.44) -0.01 (-0.15) 0.79 (1.44) -0.94* (-1.87) -1.06** (-2.06) 2 1.54*** (4.44) 3 1.52*** (4.26) 4 5 6 2.19*** (5.11) 7 2.12*** (4.83) 8 9

125

0.71* (1.67) -1.36*** (-2.70)

0.76* (1.78) -1.45*** (-2.86)

0.62 (1.13) -3.76*** (-4.96) 2.05*** (3.52) -0.31*** (-2.73)

0.62 (1.11) -3.72*** (-4.64) 1.84*** (3.11)

1.71*** (3.75) 0.31 (0.56) -2.74*** (-3.78) 2.03*** (3.00) -0.41*** (-3.60)

1.82*** (3.98) 0.40 (0.73) -2.82*** (-3.70) 1.94*** (2.85)

0.04 (0.79) -0.85* (-1.66) 0.06*** (10.34) 0.96*** (22.70) 0.39*** (10.43) -0.19*** (-4.19) 1.40*** (7.25) -2.12*** (-12.72) 0.00 (0.06) -14.09*** (-23.46) 29,300 9,281 0.11

-0.75* (-1.66) 0.06*** (10.37) 0.95*** (22.64) 0.38*** (10.45) -0.18*** (-4.06) 1.42*** (7.45) -2.09*** (-12.83) 0.00 (0.09) -13.93*** (-23.72) 29,969 9,508 0.11

0.01 (0.15) -1.05** (-2.12) 0.06*** (10.25) 0.95*** (22.62) 0.39*** (10.44) -0.19*** (-4.21) 1.41*** (7.29) -2.11*** (-12.68) 0.01 (0.12) -13.85*** (-23.38) 29,300 9,281 0.11

-3.29*** (-3.97) 0.06*** (8.85) 0.90*** (19.39) 0.39*** (10.32) -0.10** (-2.09) 1.42*** (5.88) -1.39*** (-7.94) -0.02 (-0.39) -12.88*** (-17.94) 12,817 4,351 0.14

-0.51*** (-4.01) -3.48*** (-3.85) 0.06*** (8.56) 0.89*** (19.16) 0.40*** (10.46) -0.11** (-2.24) 1.44*** (5.84) -1.40*** (-7.75) -0.03 (-0.54) -12.71*** (-17.43) 12,248 4,110 0.14

-4.79*** (-6.37) 0.06*** (8.75) 0.89*** (19.22) 0.39*** (10.31) -0.10* (-2.05) 1.45*** (5.98) -1.39*** (-7.96) -0.02 (-0.31) 12.00*** (-17.54) 12,817 4,351 0.14

-0.65*** (-5.14) -4.83*** (-5.83) 0.06*** (8.44) 0.88*** (18.98) 0.40*** (10.46) -0.11** (-2.20) 1.48*** (5.96) -1.40*** (-7.76) -0.03 (-0.48) -11.88*** (-17.24) 12,248 4,110 0.14

Notes: The dependent variable for all models is the natural log of corporate liquidity (i.e., the ratio of cash plus its equivalents plus marketable securities to net assets (Cash)). GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Real short-term rate (Real ST rate) is the interest rate with short term to maturity adjusted for inflation. Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's corporate tax Rate Survey. Market-to-book ratio (MTB) is defined as the book value of total assets less the book value of equity plus the market value of equity divided by total assets. Size is the natural log of total assets in millions of USD. Cash flow (CF) is earnings before interest and taxes, depreciation and amortization (EBITDA), less interest, taxes, and common dividends. Net working capital (NWC) is defined as total current assets less cash less total current liabilities. Capital expenditure (CAPX) is additions to fixed assets. Leverage (LEV) is total debt as a fraction of total assets. Dividend (DIV) is the dummy variable that takes on one if a firm pays dividends and zero otherwise. All financial ratios are winsorized at the 1% and 99% level. N represents the number of observations (firm-years); n stands for the number of firms. The numbers in the parentheses are t-statistics. ***, ** and * indicate coefficient is significant at the 1%, 5% and 10% level, respectively. In all models, year dummies are included, but the results are not reported.

126
Table 4:

International Research Journal of Finance and Economics - Issue 35 (2010)

Tests for joint significance of macro variables

Added variable(s) df1 df2 F-statistic GDP, Real ST rate, Credit, Pcredit1, Corp tax 5 20,439 7.74*** GDP, Real ST rate, Credit, Pcredit2, Corp tax 5 19,997 8.30*** Inflation, Real ST rate, Credit, Pcredit1, Corp 5 20,439 3.46*** tax Inflation, Real ST rate, Credit, Pcredit2, Corp 5 19,997 3.94*** tax GDP, Real ST rate, Deficit, Credit, Pcredit1, 6 8,443 20.16*** Corp tax GDP, Real ST rate, Deficit, Credit, Pcredit2, 6 8,115 23.46*** Corp tax Inflation, Real ST rate, Deficit, Credit, 6 8,443 16.29*** Pcredit1, Corp tax Inflation, Real ST rate, Deficit, Credit, 6 8,115 20.71*** Pcredit2, Corp tax Notes: Wald Tests are conducted to test for the significance of adding additional macro variables to the benchmark fixedeffect panel regression model, i.e., regression of corporate liquidity on the market-to-book ratio, size, cash flow, net working capital, capital expenditure, leverage, dividend-paying firms or not and year dummies (i.e., model 1 in Table 3). The dependent variable for all models is the natural log of corporate liquidity (i.e., the ratio of cash plus its equivalents plus marketable securities to net assets (Cash)). GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Real short-term rate (Real ST rate) is the interest rate with short term to maturity adjusted for inflation. Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's corporate tax Rate Survey. ***, ** and * indicate coefficient is significant at the 1%, 5% and 10% level, respectively.

International Research Journal of Finance and Economics - Issue 35 (2010)

Table 5

127

Effect of macro variables on sensitivity of corporate liquidity to firm-specific variables for 34 countries, 1994-2005
1 2
0.06*** (8.77) -0.56*** (-4.88) 0.84*** (19.88) 0.41*** (11.18)

3
0.06*** (12.68)

4
0.06*** (9.01)

5
0.06*** (12.62)

6
0.06*** (9.02)

MTB MTB*GDP MTB*deficit Size CF/net assets CF/net assets*GDP CF/net assets*deficit NWC/net assets CAPX/net assets LEV LEV*GDP LEV*deficit DIV Constant

0.05*** (9.25) 0.23*** (3.53)

0.93*** (28.05) 0.39*** (12.89)

0.93*** (28.00) 0.31*** (8.68) 1.42*** (4.15)

0.84*** (19.93) 0.39*** (10.32) -2.71*** (-3.37) -0.10** (-2.14) 1.33*** (6.34) -1.34*** (-8.60)

0.93*** (28.00) 0.39*** (12.89)

0.84*** (19.94) 0.42*** (11.54)

-0.16*** (-4.30) 1.38 *** (8.77) -2.01*** (-14.77)

-0.09** (-2.02) 1.31*** (6.26) -1.35*** (-8.66)

-0.16*** (-4.37) 1.38*** (8.78) -2.01*** (-14.75)

-0.16*** (-4.33) 1.37*** (8.72) -2.10*** (-15.08) 1.61*** (2.80)

-0.09** (-2.04) 1.34*** (6.40) -1.45*** (-9.14) -8.94*** (-4.34) 0.04 (0.73) -13.27*** (-22.95) 14,872 4,916 0.13

N n R2 Notes: The dependent variable for all models is the natural log of corporate liquidity (i.e., the ratio of cash plus its equivalents plus marketable securities to net assets (Cash)). GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Real short-term rate (Real ST rate) is the interest rate with short term to maturity adjusted for inflation. Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's corporate tax Rate Survey. Other firm-specific determinants of corporate liquidity are the same as those in Tables 3 and 4. N represents the number of observations (firm-years); n stands for the number of firms. The numbers in the parentheses are t-statistics. ***, ** and * indicate coefficient is significant at the 1%, 5% and 10% level, respectively. In all models, year dummies are included, but the results are not reported.

0.05 (1.41) -13.89*** (-28.93) 36,782 11,052 0.12

0.03 (0.53) -1 3.27*** (-22.84) 14,872 4,916 0.13

0.06 (1.48) -13.86*** (-28.89) 36,782 11,052 0.12

0.02 (0.45) -13.23*** (-22.84) 14,872 4,916 0.13

0.05 (1.41) -13.87*** (-28.89) 36,782 11,052 0.12

128

International Research Journal of Finance and Economics - Issue 35 (2010)

Appendix
Table A1 Variable definitions and sources
Variable Cash Market-to-book ratio (MTB) Size Cash flow (CF) Net working capital (NWC) Capital expenditure (CAPX) Leverage (LEV) Dividend (DIV) GDP growth rate (GDP) Inflation Short-term rate (ST rate) Deficit Credit spread (Credit) Definition Cash plus its equivalents plus marketable securities Book value of total assets less the book value of equity plus the market value of equity divided by total assets ln(total assets in USD) Cash flow is earnings before interest and taxes, depreciation and amortization (EBITDA), less interest, taxes, and common dividends. Total current assets less cash less total current liabilities Additions to fixed assets Total debt divided by total assets Dummy variable that takes on one if a firm pays dividends and zero otherwise (GDPt GDPt-1)/ GDPt-1 (CPIt CPIt-1)/CPIt-1 Interest rate with short term to maturity, including money market rate, call money rate, 3-month interbank rate, Treasury bill rate, etc. Government budget deficit/surplus as a fraction of GDP The lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country The ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP The ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP Corporate tax rate Source Worldscope Worldscope Worldscope Worldscope Worldscope Worldscope Worldscope Worldscope International Financial Statistics International Financial Statistics International Financial Statistics International Financial Statistics International Financial Statistics

Private credit 1 (Pcredit1)

International Financial Statistics

Private credit 2 (Pcredit2) Corp tax

International Financial Statistics KPMGs corporate tax Rate Survey

International Research Journal of Finance and Economics - Issue 35 (2010)

Table A2 Correlation matrix

129

GDP Inflation Real ST rate Deficit Credit Pcredit1 Pcredit2 Corp tax GDP 1.000 Inflation 0.805 1.000 Real ST rate 0.111 0.058 1.000 Deficit 0.066 -0.053 -0.147 1.000 Credit 0.202 0.204 0.391 -0.158 1.000 Pcredit1 -0.354 -0.318 -0.254 0.211 -0.276 1.000 Pcredit2 -0.437 -0.387 -0.157 -0.008 -0.239 0.660 1.000 Corp tax -0.207 -0.061 -0.222 0.084 -0.054 0.020 -0.125 1.000 Notes: This table presents the correlation matrix for the macro variables. GDP growth rate (GDP) is the percentage change in GDP. Inflation is percentage change in consumer price index. Real short-term rate (Real ST rate) is the real interest rates with short term to maturity (less than one year). Government budget deficit (Deficit) is government budget deficit/surplus as percentage of GDP. Credit spread (Credit) is the lending rate minus either Treasury bill rate, money market rate, or discount rate/bank rate, depending on the country. Private credit 1 (Pcredit1) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits and claims on the private sector given by other financial institutions that do not accept transferable deposits but that perform financial intermediation by accepting other types of deposits or close substitutes for deposits to GDP. Private credit 2 (Pcredit2) is the ratio of claims on the private sector by commercial banks and other financial institutions that accept transferable deposits such as demand deposits to GDP. All these macro variables are from International Financial Statistics. Corporate tax rates (Corp tax) are from KPMG's corporate tax Rate Survey.