The Influence of Cash Holdings on Firm Performance: A Theoretical and Empirical Assessment from Pakistan

Abstract

This paper examines how cash holdings affect the firm performance using data of 202 non-financial listed firms on Pakistan Stock Exchange between 2013 and 2022. As theories, the research relies on the trade-off theory, pecking order theory, and agency theory that in combination has been used to justify the practice of keeping corporate cash reserves and its implications on firm value. Firm performance has been evaluated as Return on Equity (ROE) and cash holding is a proxy of cash and cash equivalents to total assets. Firm-specific control variables such as firm size (log of total sales), leverage (debt-to-equity ratio), growth opportunities, and asset tangibility also form part of this model in a bid to appreciate their significance in determining the corporate liquidity and financial performance. To make a robust study, the study utilizes the Panel Ordinary Least Squares (POLS) model, fixed effects (FE) model, and random effects (RE) model, backed by the standard diagnostic tests, such as the unit root tests, correlation test. The empirical findings reveal that there is a very strong and statistically significant positive association between cash holding and firm performance, which demonstrates that appropriate liquidity improves the capacity of a firm to invest, mitigate risk and prevent instances of financial distress within the fields of trade-off and pecking order theorizations. Besides, leverage is noted to have a negative relationship with cash holdings and firm size, growth opportunities and tangibility evidenced positive relationship thus confirming the theoretical assumptions. The results are significant to corporate finance decision-makers in the emergent market such as Pakistan where less access to external financing is either not available or very expensive. The contribution of the study to the existing literature on financial management, as well as to a practical one, lies in identifying the strategic significance of the internal liquidity which is an aspect that should be taken into account by firms that intend to enhance their performance through the application of efficient cash management policies.