The Inefficient Corporate Cash Buffer and the Nonlinear Business Cycle
This paper studies the macroeconomic implications of corporate cash holdings over the business cycle. We develop a heterogeneous firm business cycle model in which firms accumulate cash for precautionary reasons. Firm-level cash accumulation is highly nonlinear due to a satiation point. This nonlinearity survives aggregation, shaping the aggregate allocations’ state-dependent responsiveness to TFP shocks. In periods of high cash holdings, firms can smooth dividend payouts, thereby dampening the response of aggregate consumption to adverse TFP shocks. Despite this stabilizing role, we show that the decentralized equilibrium level of cash holdings is inefficiently high due to a negative cash externality. We conclude by providing micro-level empirical evidence in support of the model’s key mechanisms.
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