Real Option Component of Cash Holdings, Business Cycle, and Stock Returns

Uncertainty of uncertainty and firm cash holdings

“…For instance, Gulen and Ion (2015) evidence a strong negative relationship between firm-level capital investment and the aggregate level of uncertainty associated with future policy and regulatory outcomes. Chen, Jia, and Sun (2016) find that corporate managers tend to preserve cash with an expectation of a worse economy while spend cash to exercise growth opportunities with a favorable economic condition. A number of articles have modeled relationships between firm cash holdings and uncertainty of either future cash flows or uncertainty regarding investment opportunities (e.g., Chen, Jia, and Sun, 2016;Han and Qiu, 2007;Hugonnier, Malamud, and Morellec, 2014;Kim and Kung, 2016).…”

“…Im, Park, and Zhao (2017) report that a firm facing higher uncertainty will assign a higher value to cash because of increased value of real options (see also Opler et al, 1999). Chen, Jia, and Sun (2016) suggest corporate managers prefer to preserve cash when there are expectations of economic worsening with a view to subsequent spending of cash to exercise growth opportunities during later favorable economic condition.…”

Relationship between cash holdings and expected equity returns: evidence from Pacific alliance countries

“…Also, we eliminated firms with negative equity, firms with a total debt to total asset ratio greater than one, and firms with a negative dividend pay-out ratio (Simutin, 2010; Sodjahin, 2013; Palazzo, 2012; Wang, 2012). To reduce the impact of outliers, we winsorized accounting variables at the top and bottom 1% to avoid the results of the analysis being affected by extreme values (Brick and Liao, 2017; Chen et al , 2016; Palazzo, 2012). Our final sample consisted of an unbalanced panel with 215 firms and 3,361 observations.…”

“…Likewise, this relationship was tested by Rao et al (2013), who concluded that cash holdings can predict the future performance of a firm's stocks and that firms with higher cash holdings, on average, experience higher returns, suggesting that investors should pay close attention to cash holdings when making investment decisions. More recently, Chen et al (2016), using a real option component of cash holdings, concluded that stock returns of firms with higher cash holdings have a positive correlation with the shock to the real option component.…”

Are real options a missing piece in the diversification-value puzzle?

“…Additionally, and as a robustness control, we re-estimate the model with the widely-used variable of market-to-book assets ratio (MBAR) (e.g. Adam and Goyal, 2008;Chen et al, 2016), which is computed as in Adam and Goyal (2008). The explanatory variable is the degree of diversification (DIVER), which we approximate by three different measures commonly used in diversification literature in order to test the robustness of our empirical findings: the number of businesses, the Herfindahl index (Hirschman, 1964), and the entropy measure (Jacquemin and Berry, 1979).…”