Why do firms hold so much cash? An innovation explanation

Theory holds that knowledge has positive economic consequences. While US corporations defend record high level cash holdings citing the precautionary motive in response to changing firm characteristics, I find that knowledge-based innovation can partially explain these changes. Using distance to the nearest research university as a measure of knowledge intensity, I show that knowledge-intensive firms hold more cash, even after controlling for firm R&D. Moreover, knowledge-intensive firms exhibit higher marginal value of cash and save more cash from cash flows than their less knowledge-intensive counterparts. Overall, the precautionary motive appears to dominate the agency motive, with the effect of knowledge on cash holdings strengthening over time. Copyright (c) 2014 ASAC. Published by John Wiley & Sons, Ltd.