Abstract

     This paper adds to the recent interest in the link between cash and firm performance, by studying how this relationship varies across boom- and bust cycles. We use data of Norwegian firms from a broad range of sectors in the period 2005–۲۰۱۵, and both replicate and extend previous findings on the relationship between cash and performance over the business cycle. We find that i) cash has a positive, but weakly diminishing effect on operational firm performance (ROA) throughout the entire sample period, and ii) that the curvilinear relationship between cash and firm performance is the most pronounced in the pre-recession years, while it is virtually linearly positive in recessions and post-recession periods. We conclude that cash indeed has an impact on firms’ operational performance, and especially so in recessionary times.

Introduction

     Traditionally, strategy scholars have disregarded cash as a strategic asset (e.g. Barney, 1986), while finance scholars have viewed cash holdings as a signal that a firm lacks profitable investment opportunities or have managerial issues (e.g. Jensen, 1986). Recent studies have questioned these views by documenting that cash may indeed be positively related to performance (Kim & Bettis, 2014), and that contextual factors such as state of the business cycle (Nason & Patel, 2016) and competitive dynamics (Deb et al., 2017, Jung et al., 2020, O’Brien and Folta, 2009) are important moderators for the strength of the cash-performance relationship.

     While this recent research stream has made important advancements to our understanding of the relationship between cash and firm performance, we know less about how these insights can be generalized to other contexts than large, listed (manufacturing) companies operating in relatively stable periods, and if relationships between cash and market-based measures of performance also holds for operational measures of performance. Currently, most studies on the cash-performance relationship use samples of large, listed, US, (manufacturing) firms (e.g. Deb et al., 2017; Jung et al., 2020; Kim & Bettis, 2014; O’Brien & Folta, 2009), study relatively stable periods and not more turbulent times such as economic downturns where financing constraints tends to increase (Forseth et al., 2015), and/or use market-based measures of firm performance such as Tobin’s Q as their dependent variables (e.g. Deb et al., 2017; Jung et al., 2020; Kim & Bettis, 2014; O’Brien & Folta, 2009).

Conclusion

     The purpose of this paper was to examine the relationship between cash and firm performance over the business cycle.

     Throughout our analysis we find that cash has a positive impact on firm performance across the different phases of the business cycle. The linear term of cash is highly significant in all our models and across all time periods. The quadratic term is less consistent; in some cases, we identify a curvilinear relationship, whilst sometimes the quadratic term is low and insignificant indicating a linear relationship between cash and firm performance.

     After running our full and expanded models, we conclude that the curvilinear relationship between cash and performance is weakly curvilinear for our sample of Norwegian firms, and that this curve-linearity is the most pronounced in the pre-recession period, and more or less linear during the recession and post-recession periods.

     In closing, we believe that our results add to an important stream of research at the intersection of strategy and finance. Mainstream theories, especially in strategy discard cash and other financial assets as less important drivers for heterogeneity and performance differences. Our findings, and the findings of the studies we build on, challenge these assumptions. It is, however, important to note that cash seems more likely as an indirect source of performance differences, through enabling firms to make investments and deploy strategies that in turn create performance heterogeneity. That is, cash appears to be less of a king, but more a key member of the court that pull some important strings.