Precautionary Cash and Asset Tangibility in Europe: A New Measure for Unobservable Financing Constraints?

This paper provides novel evidence on the accumulation of precautionary cash by European firms over 2000-2017 using a difference-in-difference approach. By increasing corporate borrowing capacity, rising asset tangibility is found to have reduced the need for precautionary cash amongst constrained firms, as implicit in the credit-multiplier story. The least productive firms released increasingly more cash than the most productive ones because decreasing returns to scale reduce the benefit from holding any additional unit of cash for the purpose of (self)-financing future investment. Relatedly, the sensitivity of cash to physical capital is found to be a good proxy for otherwise unobservable financing constraints because it increases with the wedge between the costs of internal and external finance, as in the so-called monotonicity hypothesis. These results contribute to a better understanding of, for example, recent trends in capital allocation.