Cash Holdings and Competition

We use a dynamic cash management model in which firms face competitive pressure to show that product market competition increases the cash holdings as well as the size and frequency of equity issues of financially constrained firms. We test these predictions on Compustat firms for the period 1980-2007 and show that product market competition has first order effects on the cash management and financing decisions of constrained firms, in ways consistent with our theory. Also consistent with the model, we find that unconstrained firms' cash holdings and financing decisions are not systematically related to product market competition. Finally, we show that the time trend in cash holdings documented by Bates, Kahle and Stulz (2009) can be at least partly attributed to a competition effect.