Testing the Validity of Financial Determinants of Corporate Cash

Holdings Using Empirical Analysis: Evidence From India

By Parangat Kapur, Parv Maheshwari and Rishabh Bansal

Class: BMS 2D, Roll Number: 18100, 18104 and 18125

Abstract

The objective of this paper is to investigate the financial determinants of corporate cash holdings in the
Indian market. The paper discusses the importance and need of cash holdings, and thereon, moves to
identifying relevant financial determinants of corporate cash holding and hypothesising their impact on
or relationship with corporate cash holdings based on research conducted by acclaimed academia in the
past. With the aid of a representative sample from the Indian market, an empirical analysis is conducted
to test the relationship of financial leverage, dividend payments, profitability of firms, growth
opportunities, size of firm, capital expenditure, net working capital and cash flow volatility with corporate
cash holding. These relationships are tested with the aid of relevant statistical tools, and thereon, the
validity of the test statistic is ascertained with the aid of apropos significance tests. This paper is not
limited to the overall industry but also digresses into individual sectors of the industry to identify
relationships, test for their existence and nature, and finally ascertain the validity of the identified
relationships for each sector.

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I. Introduction

Cash Holdings are the lifeblood of an organization. It is the lubricant that ensures smooth functioning of
an organization. As per Almaria Morar, “Cash is the fuel that makes the business go, without a healthy
cash flow a business cannot survive”. Therefore, Corporate Cash Holdings and its management have
garnered widespread interest by acclaimed academicians worldwide.

Accumulation of cash surplus across corporations globally has accentuated the curiosity to delve deeper
into the determinants of Corporate Cash Holdings over the last quarter-century. Companies like Nintendo,
Microsoft and Amazon continue to boast a large cash holding. Indian Companies turned south as their
cash holdings came down from ~12.69% in 2014 to ~5.84% in 2018. This can partly be explained by
several structural changes due to Demonetization and GST. However, it is important to identify certain
fundamental parameters governing the level of Corporate Cash Holdings regardless of the noise created
by such disruptive trends.

This paper relies on past literature for identification of the various fundamental parameters governing
Corporate Cash Holdings and explores whether these hypothesized determinants are significant despite
significant alterations in Cash Holdings patterns in India. We contribute to the existing literature by
investigating whether the identified determinants hold relevant and significant and comparing the results
obtained with previous literation.

The analysis that follows is based on a sample of 15 companies across 4 key sectors - Automobile,
Consumer Goods, Information Technology and the Pharmaceuticals. The choice of sectors is based on
the following two facts. One, they comprise the largest companies and two, they are reasonably diverse
and have relatively lower horizontal and backward integration. This results in an analysis of independent
impacts free from hidden systematic spillovers. The study leverages the tools of Karl Pearson’s Product
Moment Coefficient and Student’s t-test which together give a true representation of statistically
significant correlated movements both within industries and across them at the period relevant to our
study [2014-2018].

Our results indicate that cash flow volatility, working capital requirements, and profitability significantly
affect cash holding for organizations in India. The study takes into consideration that each sector has
some fundamental differences from other sectors and hence dissection across sectors helps to further our
analysis. The remainder of this paper is organized as follows: Section II discusses the literature review;
Section III develops the hypotheses; Section IV emphasizes the objectives of the study; Section V
describes the methodology and sample selection; Section VI highlights the results; Section VII delivers
the conclusions; and finally, Section VIII reports the limitations of the study.

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II. Theory and Literature Thesis

This section intends to assemble all significant theories which lay the groundwork for the development
of directional hypothesis to be analyzed in the upcoming sections.

The oldest literature on the topic dates back to Keynes (1936) who stated that four-fold motives primarily
dictate firms’ demand for money. First, the transactional motive or the need to conduct transactions of all
kinds. Second, precautionary motive or the need to ensure safety and security against unfavourable
conditions detrimental to a firm’s interest. Third, tax motive or tax-saving by repatriating profits earned
as cash in countries serving as tax havens for tax avoidance. Fourth and finally, the agency motive, which
along with tax motives, has been largely excluded from our research even though it is indeed recognized
that agency problems prop up as firms accumulate cash (Jensen, 1986).

Corporate Governance is indeed related to cash holding requirements but the fact is that: a) it can be
argued that it does not remain seemingly tangible and b) Corporate Governance is about an organization’s
management and their discretion. Hence, it can be argued that an exercise of such discretion dictating
cash choices also spans transactional and precautionary motives on their part even if the same pertains to
personal benefit (Opler et al., 1999).

Trade-off theory
The trade-off theory of capital structure (Modigliani and Miller,1958) is the idea that a company chooses
how much debt finance and how much equity finance to use by balancing the costs and benefits.

As per trade-off theory, we have identified two costs of holding cash:

• If we assume that managers maximize shareholder wealth, the main cost incurred by keeping cash is
the opportunity cost of the capital that has been invested in liquid assets (M.A. Ferreira, A.S. Vilela.,
2010), which is also referred to as cost-of-carry. Cost-of-carry can be defined as the difference between
the return on cash and interest that would have to be paid to finance an additional unit of cash.

• On the other hand, if managers decide to not maximize shareholders' value, they boost their cash
holdings to increase assets under control, thereby enabling them to increase their managerial
discretion. Hence, the cost of cash holdings will go up and include agency cost of managerial
discretion, which as recent literature puts it, determines the degree of private benefit extraction (Jensen,
1986). Liquid assets such as cash can be converted into private benefits at a lower cost (Myers and
Rajan, 1998).
Agency costs refer to internal costs incurred due to the conflicting interests of shareholders (principals)
and the management (agents).

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The benefit of holding cash has two objectives, which are:

• Transaction costs motive: The primary advantage of keeping cash is that the firm saves transaction
costs to raise funds and thus doesn’t need to liquidate its assets to meet payment requirements (Dittmar
et al., 2003; Miller & Orr, 1966; Tobin,1956). As a result, firms will hold more cash when higher
transactions costs to convert non-cash assets to cash are more likely

• Risk of greater opportunity costs: Alternatively, firms will tend to hold a lower amount of cash when
the opportunity costs of cash retention are greater. The precautionary motive emphasizes that a firm
can use the liquid assets to finance its activities and investments if other sources of funding are not
available or are excessively costly.

Pecking order theory

In Corporate Finance, the pecking order theory (Myers (1984) and Myers and Majluf (1984)) postulates
that the cost of financing increases with asymmetric information. Information asymmetry refers to a
situation wherein one party has more or better information than the other. Financing flows in from three
sources, internal funds such as reserves, debt and equity. Companies prioritize their sources of financing
in the order of internal financing debt and equity as a "last resort” (see among others Al-Najjar, 2011;
Booth et al., 2001).

If we extend this theory in an attempt to identify the determinants of cash, we can claim that there is no
optimal cash level but on the other hand, cash acts as a buffer between retained earnings and investment
needs. Under this theory, the level of cash would be a function of financing and investment decisions
(Dittmar et al., 2003).

• Consequently, Dittmar et al. (2003) also postulated that when current operational cash flow is enough
to fund fresh investments, firms use the same to service debt, to reward shareholders (dividend) and
finally to accumulate cash.

• When retained earnings are insufficient to finance current investments, firms use the accumulated cash
holdings and issue new debt, if required and finally when they get out of their debt-servicing capacity
they will issue securities.

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Free cash flow theory
Jensen (1986) suggests that entrenched managers would prefer to retain cash balances over increased
payment to shareholders through dividends when the firm is faced with poor investment opportunities.
They have reason to stash and hoard cash to increase the total value of assets under their control and to
gain power over the firm’s investment decision (Jensen, 1986 and Stulz, 1990). By retaining excess cash
flow, managers reduce the ongoing need for raising finance from the capital markets, thereby giving them
the freedom from capital providers’ monitoring.

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III. Determinants of cash holding || Development of Hypotheses

A. Leverage
In line with the transaction cost motive, highly levered firms face high costs when investing in liquid
assets and should hence hold less cash (Baskin, 1987). In emerging markets, bankruptcy-related costs are
also important, since different studies in the emerging market context find evidence for these costs.
Further, according to the pecking order theory, cash holdings should decrease with leverage, because if
internally generated funds are not sufficient, firms will use its liquid reserves before issuing debt, but if
the firm has internal surplus it will pay down its debt (Al-Najjar & Belghitar, 2011; Ozkan & Ozkan,
2004). On the other hand, free cash flow argument suggests that payouts, in the form of interest payments,
reduce the resources under the management, thereby reducing managers' power and increasing the
likelihood of monitoring by the capital markets. However, low leverage firms subject to a lower level of
monitoring, which makes room for superior managerial power (Ferreira and Vilela, 2004). A growing
number of studies have found that the level of financial leverage negatively affects corporate cash
holdings.

Our first hypothesis is:

H1: There is a negative relationship between leverage and cash holdings.

B. Dividend payments
Based on the trade-off theory, the relationship between dividend payments and cash should be negative,
since firms that pay dividend can trade off the costs of holding cash by reducing dividend payments (Al-
Najjar & Belghitar, 2011). This can also be seen in terms of lesser precautionary demand for money due
to greater goodwill and better access to capital markets.

Based on the trade-off theory, we hypothesize that:

H2. There is a negative relationship between dividends and cash holdings.

C. Profitability
According to the pecking order theory (Myers.,1984), firms with higher financial results retain a higher
level of liquidity because profitable firms accumulate the cash flow generated. Consequently, controlling
for investment, the most profitable companies should have more cash.

Based on the pecking order theory we hypothesize that:

H3. There is a positive relationship between profitability and cash holdings.

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D. Growth opportunities
Based on the trade-off theory, there is a positive association between growth opportunities and cash
holdings. The opportunity cost due to a lack of liquidity should be more severe for firms with high-quality
investment projects. Also, the financial distress costs for these firms are higher which can make the
external financing more expensive. To avoid these costs, firms with high-quality investment project will
have a propensity to provide liquidity in order not to run the risk of underinvestment in the future.
Therefore, to avoid any shortfall in cash is per transaction motives of cash. (Opler et al., 1999 and Ozkan
and Ozkan, 2002). The second motive of avoiding financial distress is consistent with the amotive of
precaution. Similarly, the pecking order theory argues for a positive link between growth opportunities
and cash holdings. Firms with higher growth opportunities need higher cash level to cope with any
shortfall in cash.

Hence, we hypothesize that:

H4. There is a positive relationship between growth opportunities and cash holdings.

E. Firm size
Because of diversification, larger firms have more stability of cash flow and therefore they have a lower
probability of being in financial distress (Kalcheva and Lins, 2007). It would be easier for these firms to
have access to diversified funding sources, which is often not possible for a smaller one. Consequently,
they are less likely to store cash reserves. In line with these arguments, big firms are more likely to be
able to liquidate part of non-core assets to obtain cash, which reduces the likelihood of encountering
financial distress. Barclay and Smith (1995) and Kim et al. (1998) contend that larger firms are better
able to exploit the scale economies because they raise large amounts of capital frequently. Contradicting
the trade-off view, the pecking order theory affirms that cash holdings increase with firm size because
larger firms are expected to have been more profitable historically and thus accumulated more cash
(Faulkender and Wang, 2006).

Thus, we argue that firm size is an important determinant of cash holdings and do not predict the sign of
the association between firm size and cash holdings:

H5. There is a negative/positive relationship between firm size and cash holdings.

F. Capital expenditure
Based on the pecking order theory (Myers.,1984), firms that have greater investment expenses have a
surplus from internally generated funds to invest in liquid asset reserves and thus hold fewer liquid assets.
Consequently, if capital expenditures create assets that can be used as collateral, capital expenditures
7
could increase the ability to undertake debt and reduce cash demand. Equally far-reaching is productivity
shock for firms which temporarily increases capital expenditure and lessens savings, implying a lesser
need for cash (Riddick and Whited 2009).

Hence, there will be a negative relationship between capital expenditure and cash holdings and
hypothesize that:

H6. There is a negative relationship between capital expenditure and cash holdings.

G. Net working capital

There exists an inverse association exists between cash and net working capital as per the tradeoff theory
(Ferreira and Vilela, 2004). This is because net working capital consists mostly of liquid asset cash
alternatives. The existence of liquid assets will lead firms to be less reliable on capital markets to obtain
cash (Al-Najjar & Belghitar, 2011; Ozkan & Ozkan, 2004). Furthermore, net working capital consists of
assets that substitute for cash.

Based on the empirical findings and trade-off theory, we hypothesize that:

H7. There is a negative relationship between net working capital and cash holdings.

H. Cash flow volatility

Based on the trade-off theory (Modigliani and Miller,1958), companies with greater volatility in their
cash flows face higher chances of undergoing cash shortages arising out of unexpected cash flow
deterioration, which leads them to forgo some profitable investment projects. As an outcome of
uncertainty, there are situations in which the firm has more capital outlays than they would have
estimated. Firms with greater cash flow risk hold more cash for precautionary purposes.

Based on the trade-off theory, we hypothesize that:

H8. There is a positive relationship between cash flow volatility and cash holdings.

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IV. Objectives

A. To examine whether the findings of the study conform to the theoretical arguments or not, that is, to
test the hypotheses developed above

B. To measure the extent and magnitude of the relationship between cash holdings and financial leverage,
dividend payments, growth opportunities, capital expenditure, net working capital, cash flow volatility,
size of the organization and profitability in the Indian market as well as each of the chosen sectors
under study through the application of Pearson’s simple correlation technique and testing such
correlation coefficients.

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 V. Methodology

Sample
Our data has been sourced from the Prowess database. It is supported by the Centre for Monitoring Indian
Economy and includes information on private and listed companies. It is widely used for firm-level
research on India (e.g., Gopalan, Nanda & Seru, 2007). India has two major stock exchanges: Bombay
Stock Exchange of India (BSE) and National Stock Exchange of India (NSE). The NSE was founded in
1992 and started trading in 1994 and currently stands as the 12th largest stock exchange in the world in
terms of total market capitalization as of March 2019.

Our sample (sourced from Nifty 50) comprises Fifteen major companies from four unique sectors
(Information Technology, Consumer Goods, Pharmaceuticals and Automobile).

Name of Industry Number of Companies Percentage

Automobile 5 33.33%

Consumer Goods 4 26.67%

Information Technology 4 26.67%

Pharmaceuticals 2 13.33%

Total 15 100%

Period of Study: The data of the selected companies for the period 2014-2018.

Variables Used:

S.No. Name of Variable Measurement Method

1 Cash Holdings Total Cash and Cash Equivalents / Total Assets * 100

2 Leverage Total Debt / Total Assets * 100

3 Dividend Payments Dividend per Share / Annual Stock Close Price

4 Profitability Operating Profit / Total Assets * 100

Growth
5 (Year End Market Value of Equity + Total Debt) / Total Assets * 100
Opportunities

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6 Firm Size Ln | Total Assets |

(Year 1 Fixed Assets - Year 0 Fixed Assets + Depreciation +

7 Capital Expenditure
Amortization)/ Total Assets * 100

8 Net Working Capital (Current Assets - Current Liabilities) / Total Assets * 100

9 Cash Flow Volatility Standard Deviation

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VI. Results

Introduction
Over the observation period of 2014–2018, on average, Indian firms hold ~9.26% of their net assets in
cash. Compared to others studies, it is found that average cash ratio in India is lower than those found by
Saddour (2006) of French firms over the period 1998–2002 (14.7%) and Ferreira and Vilela (2004) for
firms of EMU countries over the period 1987–2000 (14.8%). Al-Najjar (2013) finds an average cash ratio
of 5.6% for a sample of emerging countries including Brazil, Russia, India and China over the period
(2002–2008). However, Indian firms seem to be less conservative than their counterparts in other
emerging countries.

For other variables, Indian firms hold, on average, leverage of ~36%, profitability of ~24%, net working
capital of ~12%, annual Capex of 5.07%, 1035% of volatility in cash flow, and dividend payment of
2.2%. Besides, the firms of our sample have more growth opportunities which make the market value of
assets greater than the book value.

Looking at each of these variables sector-wise, using Table 1, cash holding in the Automobile, Consumer
Goods, Information Technology and Pharmaceuticals Industry stands at 2.5%, 11.5%, 18.7% and 2.1%
respectively. Moving to leverage, these numbers are 38.59%, 44.23%, 24.31% and 36.78% respectively.
In terms of profitability, the Consumer Goods sector is the most profitable of all four (38.58%) followed
by the Automobile Industry (24.35%), the Information Technology Sector (22.15%) and finally the
Pharmaceutical Industry (1.94%).

The consumer goods sector firms are largest in size with the average measure at ~12.59 (Natural Log of
actual size for easier comprehension), followed by Information Technology at ~10.79, Automobile at
~10.26 and Pharmaceuticals at the bottom with a meagre ~7.92. Moving to Net Working Capital, we
observe that the highest Net Working Capital (as a percentage of Total Assets) exists in the Information
Technology sector (~25.53%) followed by Consumer Goods (~13.19%), Pharmaceutical Sector (~8.38%)
and Automobile sector (~2.29%).

Automobile Sector has the highest capital expenditure (as a percentage of Total Assets) at ~6.09%,
followed by the Pharmaceutical Sector at ~5.635%, then the Consumer Goods Sector at ~ 5.36% and the
lowest capital expenditure being incurred by the Information Technology Sector at ~3.23%.

Cash Flow Volatility is extremely high in the Information Technology sector with a standard deviation
of -2884.82. No other sector comes close to the Information Technology Sector in this regard. They are
followed by the Automobile Sector at 36.78, then the Consumer Goods Sector at 12.27 and finally by the
Pharmaceutical Sector at -11.49.
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In terms of dividend payouts, the Information Technology Sector made the highest payments at ~4.42%.
At the opposite end of the spectrum was the Pharmaceutical Sector with dividend payments of a mere
~0.54%. In the middle lie the Consumer Goods Sector (~1.77%) and Automobile Sector (~1.42%).
Talking about growth opportunities, the Consumer Goods Sector takes the lead with a multiple of 7.22
times when the book value of equity is swapped with the market value. This is followed by the
Pharmaceutical Sector at 4.70 times, then the Automobile Sector at 3.83 times and finally the Information
Technology Sector at 2.35 times.

Table 1

Overview: Time Series Analysis

Table 2 gives a time series analysis of cash holdings as well as the financial determinants of cash holdings,
i.e. leverage, profitability, size of the firm, net working capital, Capex, dividend payments and growth
opportunities.

From Table 2, we can see that overall, cash holdings of Indian firms have dropped continuously from
2014 (~12.69%) to 2017 (~5.44%) with a negligible rise in 2018 (~5.84%).

On the other hand, leverage has fallen from ~41.74% in 2014 to ~33.04% in 2018. Profitability has shrunk
from ~30.55% in 2014 to ~16.97% in 2018, which can be attributed to increase competitiveness in the
Indian market.

The size of firms has risen from 9.94 (measured in terms of the natural log of Euler’s number) in 2014 to
10.39 in 2018.

The net working capital has risen from ~7.97% in 2014 to ~15.10% in 2018. As far as Capex is concerned,

13
it has fallen from ~5.84% to ~4.26% as firms are now looking to capitalize on capital investments made
early in 2015-16, then to continue heavy investments.

Dividend payments have fallen between 2014 (~3.73%) and 2018 (~1.45%). This is in line with falling
profitability, which has put financial pressure on firms, forcing them to pay lower dividends.

Lastly, growth opportunities have largely remained constant at about ~4.84, going as high as ~5.20 in
2014 and as low as ~4.32 in 2016.

Table 2

Correlation: The Industry

Under the ambit of this research project is not only to identify the financial determinants of cash holdings
but to also test for the existence of these financial determinants on cash holding in the Indian economy.
For this, it is important to test the hypotheses that have been developed using relevant statistical tools.

For the scope of our project, the statistical tool that has been used is Pearson’s Product Moment
Coefficient.

Pearson’s Product Moment Coefficient: In statistics, the Pearson correlation coefficient, also referred to
as Pearson's r, the Pearson product-moment correlation coefficient or the bivariate correlation, is a
measure of the linear correlation between two variables X and Y.

14
Table 3 gives the correlation of various financial determinants with cash holdings from the selected
sample over the period of study 2014-2018.

As per the calculations, we can see leverage has a very strong degree of correlation (~0.92) with cash
holdings and there exists a positive relationship between leverage and cash holdings. Profitability has a
very strong positive correlation with cash holdings (~0.98) and so do Capex (~0.95) and Cash Flow
Volatility (~0.86).

Dividend Payment is positively correlated to Cash Holdings and has a strong correlation with the same
(~0.73).

On the other hand, we see that Size of Firm and Net Working Capital are although very strongly correlated
to Cash holdings, they are also negatively correlated to the same with correlation coefficients of
approximately -0.93 and -0.97. Growth Opportunity is seen to have a negative correlation with cash
holdings and the correlation is weak.

As per this analysis, we can say that Hypotheses H3, H7, H8 seem to hold. On the other side Hypotheses
H1, H2, H4, H6 seem to hold untrue. For Hypothesis H5, we can say there exists a negative relationship
between Size of Firm and Cash Holdings.

However, it is important to test the significance of this statistical test to check whether or not they hold.

Table 3

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Scatter Diagrams

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Significance: The Industry
As discussed in the previous section, merely calculating the correlation between the financial
determinants of cash holdings and level of cash holdings itself is not enough to comment whether or not
the developed hypothesis is valid or not. Thus, it is essential to test the significance of these calculations.
For testing the significance, we have chosen to test the findings at using t-test at 5% level of significance
at the relevant degrees of freedom for each calculation.

Degrees of freedom is the number of values in the final calculation of a statistic that are free to vary. The
number of independent ways by which a dynamic system can move, without violating any constraint
imposed on it, is called the number of degrees of freedom. Correlation (r) has a t distribution with N-2
degrees of freedom, where N is the number of data points. Hence for all pairs of correlation calculations,
we have degrees of freedom at 5-2=3 (N=5). Whereas only for Capex, we have degrees of freedom at 4-
2=2 (N=4).

Table 4 gives is the p values at varying degrees of freedom, with the relevant values highlighted. For the
correlation statistic to be significant. The absolute value of the correlation (r) should be greater than the
respected p-value.

For example, for Size of Firm, the correlation value is nearly -0.93. The absolute value of the same is
nearly 0.93. Now the degrees of freedom for Size of Firm is 3, as has been established before. This gives
us a p-value of 0.878. Since 0.93 > 0.878, we can say that the test statistic is significant at 5% level of
significance. Table 5 gives us significant tests of all pairs of variables. Using the same, we can say that
the findings of hypotheses H2, H4 and H8 can neither be accepted nor be rejected, since the sample is not
representative to make a general comment on the population.

Thus, hypotheses H3 and H7 hold in the Indian Economy, hypotheses H1 and H6 hold untrue, whereas
hypotheses H5 will hold given H5: There is a negative relationship between firm size and cash holdings.

Table 4 Table 5

17
The correlation coefficient, the time series overview and the t-test combined offer us several insights
about Indian Corporates during this period. While the size of these companies symbolizes a period of
calm, it by no means holds. Cash holdings of Indian firms have dropped continuously from 2014
(~12.69%) to 2017 (~5.44%) with a negligible rise in 2018 (~5.84%). Looking at the Bird’s eye view
again, we find that leverage fell for companies implying a drawdown on the cash reserves with the
companies.

This points to greater consolidation by large-cap companies across sectors, portraying a risk-averse
attitude. This implies that the Great Indian Economic slowdown, as pointed out by Arvind Subramanium
(2019), did not directly result out of large-cap companies in these sectors which were ‘deleveraging’.
Profitability is yet another indicator that has fallen in line with cash holdings during this period. This
implies a rise in both direct and indirect cost to companies from the supply end or a shortfall in anticipated
demand during that period.

Furthermore, like most of the other indicators, a significant change took place in FY17 implying that the
impact of demonetization significantly took to companies balance sheets at the end of that very year. An
interesting indicator at this point is Working Capital, which almost seems like an inversion of cash
holdings during those 5 years. A sudden and significant rise in working capital implies either constant
supply disruptions or a dip in demand which meant that the companies’ inventories and other current
assets kept rising during this period. Capital Expenditure, the other wheel of investment, too declined,
significantly dipping in FY17 while growth opportunities rose during that period indicating a pessimistic
outlook by companies on one hand and optimism by investors on the other.

This would mean that reforms implemented and measures taken by the government were well received.
Along with that, dividend as a whole has been repeatedly declining post-2014 which seems hard to
explain apart from a decline in profitability over that period. As indicated by the statements above, we
conclude results on similar lines where profitability, firm size (total assets) and working capital have
retained their status as determinants over this course of time. This implies that measures taken by the
government have had the maximum impact (in a way that the impact created a dissociation with changes
in cash holdings) on two kinds of factors: First, which are impacted by firms’ and investors’ outlook and
Second: which are closest to the markets as factors internal continue to have a heavy degree of association
as suggested by the theory.

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Sector Wise Analysis: Correlation and Significance

Automobile
In the Automobile Sector, it is observed that there exists a very strong negative correlation between net
working capital and cash holdings at approximately-0.90. There is a strong negative correlation of cash
holdings with leverage (-0.71) and with profitability (0.79).

A similar picture is conveyed as there is a strong negative correlation of cash holdings with the size of
firm and cash flow volatility at nearly -0.71 and -0.72. Lastly, there exists a moderate positive correlation
between cash holdings and capex (0.52) and cash holdings and dividend payment (0.49). There is also a
very weak, almost negligible positive correlation between growth opportunity and cash holdings

However, when we test the significance of these statistics, we find that none of the hypothesis is
significant.

It can, therefore, be concluded that cash holdings during the period under our consideration seem to be
amongst the worst impacted sectors that cash holdings have shown high variability, taking a significant
fall in the FY17 and then jumping back up the next year, which could reflect the impact Demonetization
had. This heavy variation in cash holdings was observed for companies when their profitability was
falling. Falling profitability can largely be justified on the back of a demand slump heavy high R&D as
both oil prices and Inflation were under reasonable limits during this period.

Net Working Capital turning negative (natural log) in the year 2016 also shows a significant buildup of
stocks to distributors, who in turn failed to pay back the companies

Table 6

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Consumer Goods
In the Consumer Goods Sector, we observe that there is a very high negative correlation of cash holdings
with leverage (-0.95), profitability (0.90), size of firm (0.80) and cash flow volatility (0.97). In contrast,
there is a very high negative correlation between cash holding and net working capital at nearly -0.87,
and between cash holding and growth opportunity at approximately -0.88. It is also seen that the
correlation between cash holdings and capex is negative and weak at nearly -0.29 and that between
dividend payment and cash holdings is moderately high at ~0.63.

It is found that hypotheses H3, H4, H7 and H8 are statistically significant and H1, H2, H5 and H6 are
statistically insignificant.

It is believed that cash holdings in this sector are strongly correlated to the working capital needs. In this
case, however, rising working capital, can in part be explained by the size of the company which has
fallen on the back of dipping profitability and hence, dividend payments. Despite that, the sector looks
optimistic as it seeks to deleverage itself strengthening its fundamentals and buildup cash to capitalize on
the upcoming growth opportunities. We can further expect the sector to continue its build-up of cash
unless the government greets the economy with newer shocks.

Table 7

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Information Technology
For the pharmaceutical industry, we find that there exists a very high degree of negative correlation
between cash holdings and leverage (-0.94), profitability (0.94), capex (0.87) and dividend payment
(0.81). Conversely, a very high negative correlation exists between cash holdings and the size of the firm
(-0.94) as well as the working capital cycle (-0.98). There is weak to moderately week negative correlation
of cash holdings with growth (-0.13) and cash flow volatility (-0.36).

Conducting the significance test rules out H2, H4 and H8 for general comment. This leaves us with
hypotheses H3 and H7 which are statistically significant and hypotheses H1 and H6 which are statistically
insignificant.

Furthermore, even H5 would have held given H5: There is a negative relationship between firm size and
cash holdings. Two aspects that deserve the greatest attention for the IT Sector are - huge asset size of
the companies and staggeringly high cash flow volatility.

Even though in small proportions, the size has only risen despite falling profitability indicating higher
volumes in the IT sector and greening investor confidence (on account of better growth opportunities) on
the companies, which in turn seems to justify the declining trend of cash holdings as access to capital
markets seems high and convenient. We suspect that the company intends to engage in major M&A
activities in the future or at least intends to provide itself greater flexibility to cope with uncertainties
posed by the global environment as it builds up its working capital.

Table 8

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Pharmaceuticals
Lastly, coming to the pharmaceutical sector, we observe that capex is very highly and positively
correlated to cash holdings at ~0.83. On the other hand, cash holdings are very highly and negatively
correlated to dividend payments at ~-0.98. Cash holdings are moderately correlated to the size of the firm
(negative at ~-0.48), cash flow volatility (negative at ~-0.54), leverage (positive at ~0.41) and profitability
(positive at ~0.58). Net working capital is moderately lowly and positive correlated to cash holdings at
~0.30 and growth opportunity at ~0.38.

The significance test rules out the validity of all correlation coefficients but that of H2, which is found to
hold.

Cash holdings for pharmaceutical companies, as available literature suggests, are expected to be a
function of R&D and other capital expenditures incurred by the company. It is observable that
profitability has declined in the recent past given rising competition both in the domestic and export
markets and price fixation of several generics, equipment and drugs by the NPPA. As a result, cash
holdings seem to have declined.

The decline is further exacerbated by dividends paid by the pharmaceutical giants which in the world of
finance makes sense as the company lacked propositions to invest its money into, which is also why the
company seems to be facing a loss of confidence by the investors, especially in 2015, with a decline in
the market value of its equity even when the total assets of the companies have risen. It remains to be
seen how pharma giants regain their lost foothold on the Indian bourses. No matter what, the possibility
of reversal of the pertinent trend in cash holdings seems slight in the short term.

Table 9

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VII. Conclusion

Table 10 summarizes the findings of the existence and non-existence of the hypothesized relationships in
the Indian Market, as well as across the numerous sectors. Certain trends were observed among
companies across sectors giving us an indication of the general climate in India. Most companies showed
signs of ‘deleveraging’, consistency in total assets of the firms and falling profitability of companies
across sectors. The impact of Demonetization too could be felt observing the drastic changes that took
place in FY17.

The findings of the automobile sector and pharmaceutical sector have been ruled out as insignificant and
are hence not available for general comment. The reason for the same could be attributed to the small
sample size for the pharmaceutical sector and a volatile market for the automobile market.

It may hereby be concluded that the automobile sector has been reeling under the impact of a demand
slump which showed a significant buildup of stocks to distributors, who in turn failed to pay back the
companies. That seems precisely why the working capital in FY16 turned negative (-0.354).

In the pharmaceutical sector, it has been established that payment of dividends is inversely related to cash
holdings which could be an attempt to regain the lost investor confidence in pharmaceutical such
companies as several other regulatory and non-regulatory constraints severely dented the same.

The information technology sector most closely replicates the findings of the entire industry since it
matches all findings but that of the relationship between the size of the firm and cash holdings, which is
negatively related in the IT sector.

This replication argument can be made because of the size of IT sector companies in India, which are the
largest (as a set) not only in terms of market capitalization but also in terms of exports. Exports relatively
guarded these companies against potentially detrimental (as observable for the other sectors) reforms in
the domestic economy.

Alongside that, IT sector companies have upped their working capital, which could be an effort to impart
flexibility for protection or an attempt to make big bets on other companies.

The consumer goods sector is the only sector in which the relationship between cash flow volatility and
cash holdings is available for comment. This relationship is also found to be true. Companies have again
reported increasing working capital. This can partly be explained by the size of the company which has
fallen on the back of dipping profitability and through that dividend payments.

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Overall for the industry, we can say that the effect of cash flow volatility, dividend payments and Capex
on cash holdings cannot be determined. The effect of leverage and capital expenditure stood opposite to
what was hypothesized, whereas, for the remaining variables, the findings conform to our hypotheses.

Table 10
True*: True given H5: There is a negative relationship between firm size and cash holdings.

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VIII. Limitations of the Study

1. The study is based only on the data contained in published financial statements.

2. The impact and effect of macroeconomic factors have not been considered in the course of this for
simplicity.

3. More companies can be selected from the selected sectors, as well as more sectors could have been
selected from the Indian industry but for simplicity, lack of time and unavailability of data it is not
possible to do so for general comment.

4. The sample contains companies which are the largest in terms of market capitalization. However, it
was being argued that small and large corporates do not behave the same in respect of cash holdings.

5. A multivariate regression analysis too could have widened the scope of our research and made our
findings more robust.

6. The study could have been conducted over a greater period than 2014-2018 but for simplicity and due
to lack of time, it is not possible to cover a longer period for general comment.

7. The data has been sourced from secondary sources which may be subject to some degree of
incongruous information.

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