Liquidity Power or Liquidity Trap? Governance, Institutional Quality, and the Value of Corporate Cash Holdings

Abstract

Corporate cash holdings provide firms with financial flexibility, yet their economic value depends on the conditions under which liquidity is accumulated and deployed. This study examines how financial risk, corporate governance, and institutional quality jointly shape corporate cash-holding decisions within a dynamic and institutionally heterogeneous setting. Drawing on complementary precautionary, agency, and institutional perspectives, the study uses Liquidity Power and Liquidity Trap as interpretive lenses for understanding when corporate liquidity enhances financial flexibility or becomes associated with inefficient retention. The empirical analysis covers 528 nonfinancial listed firms across nine Asian economies over 2018–2023, yielding 2964 firm-year observations. A two-step System Generalized Method of Moments estimator is employed to account for cash-holding persistence, potential endogeneity, reverse causality, and unobserved firm-specific heterogeneity. The results indicate that financial risk is positively associated with corporate cash holdings, suggesting that firms respond to heightened financial uncertainty by strengthening precautionary liquidity buffers. Growth opportunities do not exhibit a statistically significant direct effect, while leverage and asset tangibility are negatively associated with cash holdings, and intangible intensity is positively associated with liquidity retention. Governance quality is negatively related to cash holdings, consistent with the view that stronger monitoring constrains excessive liquidity accumulation. Institutional quality has no significant direct effect but significantly moderates the relationship between financial risk and cash holdings, indicating that stronger institutional environments attenuate firms’ reliance on internally retained liquidity as financial risk increases. Robustness tests using alternative variable proxies, alternative estimators, and subsample analyses yield broadly consistent evidence. The findings contribute to the corporate liquidity literature by demonstrating that the economic role of cash is conditional on firm-level governance and country-level institutional conditions rather than determined by financial risk alone.