October 29, 2025 – Beijing – Why do corporations around the world hold so much cash? Wang Neng, CKGSB Dean’s Distinguished Chair Professor of Finance and Senior Associate Dean, addresses this long-debated question in his new study conducted with co-authors Nan Chen from the Chinese University of Hong Kong, Xavier Giroud from Columbia Business School and Ling Qin from ShanghaiTech University. The study, which he presented at a CKGSB academic seminar on October 29, provides a rigorous new framework for understanding firms’ cash-holding behavior and offers a quantitative explanation for persistently high corporate savings levels.
In their paper, “What Drives Corporate Savings,” the authors extend the standard q-theory of investment to account for both financing frictions and multiple sources of productivity shocks. Their model successfully reproduces the high levels of corporate cash holdings observed in real-world data—something previous models struggled to achieve.
“Capital markets are not perfect,” explained Professor Wang. “If a firm has to pay financing costs when raising external capital, from, say, equity markets, then naturally, firms try to stay away from raising equity. Then how does a firm finance its operations, investment and M&As? One natural source of margin is the firm’s internal funds. But the firm has to first retain earnings over time to have savings, which it can use for its rainy day or finance its investment and business operations.”
The study finds that when firms face uncertainty and costly external financing, they prefer to rely on internal cash reserves rather than external funds. “The costlier it is for firms to have external equity, the higher demand firms have for internal savings,” Wang explained.
This dynamic becomes especially important in the face of contemporaneous demand or productivity shocks. “What is a contemporaneous shock? Consider an investment made at the beginning of a year and its return will be realized at the end of the year. By a contemporaneous shock, we simply mean that the realized return over the year is random. You may think this is pretty obvious. But the standard dynamic models developed in corporate finance do not feature such a shock. That is, the one-period return in existing models in the literature is deterministic, which is not only counterfactual but has significant implications on corporate cash holdings.” he said. “When this randomness becomes important, then you’re no longer able to match internally generated cash flows to fund your next period’s desired level of investments. So, the randomness of your cash-holding positions and your internally generated cash flows will drive you to hold cash for a precautionary motive. That’s the key mechanism of our analysis.”
With rising global uncertainty, Professor Wang believes this trend will persist. “In today’s environment, as we know, there’s much uncertainty, COVID being a prominent example. Not long ago, we did not anticipate Russia-Ukraine and Israel-Hamas wars. In the highly uncertain world, firms’ forecast of their future profitability will be noisier. Risks are larger,” he said. “I expect firms’ cash holding will remain significant… as households, firms naturally have incentives to be a buffer stock saver, to save for a rainy day, and to be precautionary.”
Professor Wang’s findings highlight that corporate cash hoarding is a strategic, state-contingent rational response to uncertainty and imperfect capital markets.
This new framework helps explain why corporate cash balances remain high even in periods of low interest rates. It also provides a theoretical foundation for policymakers and analysts seeking to understand corporate liquidity demand and the implications of corporate cash holding for investment and macroeconomic stability.
