ETF ownership and corporate cash holdings

• Published date: 01 November 2022
• Author: Izidin El Kalak,Onur K. Tosun
• Date: 01 November 2022
• DOI: http://doi.org/10.1111/eufm.12352

DOI: 10.1111/eufm.12352

ORIGINAL ARTICLE

ETF ownership and corporate cash holdings

Izidin El Kalak |Onur K. Tosun

Cardiff Business School, Cardiff, UK

Correspondence

Onur K. Tosun, Cardiff Business School,

Aberconway Bldg., Colum Dr., Cardiff, UK.

Email: TosunO@cardiff.ac.uk

Abstract

Do exchange‐traded funds (ETFs) influence corpo-

rate cash holding decisions? Consistent with reduced

managerial learning from the stock market and in-

creased uncertainty due to higher ETF ownership,

we show that firms included in ETF baskets have

higher cash holdings as a precautionary response.

We address endogeneity concerns through different

natural experiments, namely, the reconstitution of

the Russell 1000/2000 index and BlackRock's acqui-

sition of iShares. We identify changes in revenue,

external financing, share repurchases and net

working capital as potential channels through which

cash holdings increase due to higher ETF ownership,

with cash holdings increases having a positive im-

pact on firm value.

KEYWORDS

cash holdings, cash value, exchange traded funds, managerial

learning, share price informativeness

JEL CLASSIFICATION

G14, G23, G32

Eur Financ Manag. 2022;28:1308–1346.1308

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wileyonlinelibrary.com/journal/eufm

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2022 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We thank Professor John Doukas (the Editor), an anonymous reviewer, Woon Sau Leong, the discussant and parti-

cipants at Cardiff‐Newcastle‐Xiamen Workshop (2019) and BAFA‐SIG conference (2019) for their insightful comments.

All remaining errors are ours.

1|INTRODUCTION

Exchange‐traded funds (ETFs) have grown significantly at the turn of the century,

1

enabling

investors to participate in stock markets and hold diversified portfolios with fewer associated

costs. However, this rapid increase of ETFs has raised concerns among policymakers, practi-

tioners and researchers.

2

To assess the effect of these investment vehicles, the majority of

studies focus on the asset pricing implications of ETFs on the stability of their underlying

equity markets (e.g., Agarwal et al., 2018; Ben‐David et al., 2018; Glosten et al., 2021; Israeli

et al., 2017).

While ETFs are classified as passive funds, that is, following an index, they lend themselves

to be unique financial instruments compared to other types of passive investors. Their un-

iqueness stems from their ability to provide investors with continuous access to the market at

low trading costs, attracting short‐term and uninformed traders and leading to high‐frequency

demand on their shares (Ben‐David et al., 2017). This affects the share price informativeness

and liquidity of the underlying stocks (Hamm, 2014; Israeli et al., 2017). In addition, unlike

other passive investors, ETFs engage in arbitrage activities that have implications on the un-

derlying stocks, such as changes in pricing efficiency and non‐fundamental volatility (Agarwal

et al., 2018; Ben‐David et al., 2018; Bhattacharya & O'Hara, 2018). Further, a recent study by

Easley et al. (2021) documents the growing role of active ETFs over time.

There is well‐established literature examining the implications of passive ownership on

firms’asset pricing and corporate policies (Appel et al., 2016; Boone & White, 2015; DeLisle

et al., 2017; Kacperczyk et al., 2018). Considering how ETFs differ from passive ownership,

there is a need to look at ETFs separately from other passive investors in relation to their effects

on firms’corporate policies. In this paper, we contribute to the ETF literature by studying

whether ETF ownership impacts corporate cash holdings policy.

Cash holdings management is at the core of firms’financial policies. Hoarding cash enables

firms to secure the financing of future investments and reduce reliance on costly external

financing (Acharya et al., 2007; Almeida et al., 2004). Further, cash has been the most easily

accessible form of assets for the use of managers and major shareholders (Schauten et al., 2013).

This, in turn, allows managers to strategically change the level of cash holdings in response to

future changes in information flow from stock prices (Frésard, 2012).

A well‐known channel through which managers learn about new information is the sec-

ondary financial markets via share prices (Bond et al., 2012; Subrahmanyam & Titman, 1999).

Several studies find support for an informational channel from stock prices to managerial

corporate decision‐making (Q. Chen et al., 2007; de Cesari & Huang‐Meier, 2015; Luo, 2005).

Theory and economic intuition propose a wide range of useful information that managers can

learn from and incorporate into their decision‐making. For, example, managers learn new

information from share prices about their firms’future investment and financing opportunities

(Dow & Gorton, 1997), the value of new strategies (Foucault & Frésard, 2012) and unexpected

cash flows and changes to discount rates (de Cesari & Huang‐Meier, 2015). Most importantly,

1

There were 1988 US‐based ETFs, with $3.4 trillion in assets under management, at the end of April 2018, according to

the 2019 Investment Company Yearbook. Ben‐David et al. (2017) note that ETFs contribute around 10% to the market

capitalization and 30% to the trading volume of securities traded on US stock exchanges.

2

For example, a recent publication by the Financial Stability Board calls for ‘closer surveillance of potential

vulnerabilities’related to the growth in ETFs. See ‘Potential financial stability issues arising from recent trends in

Exchange‐Traded Funds (ETFs)’, available at https://tinyurl.com/yarwlbk2.

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Frésard (2012) highlights the role of stock price informativeness on managerial decision‐

making concerning cash holding levels.

The growing investments of ETFs in the equity market have motivated researchers to

investigate the effect of ETF ownership on the underlying firms’share price informativeness.

This literature finds that increased ETF ownership is associated with the lower transmission of

firm‐and macro‐specific information to managers. For, example, Israeli et al. (2017) show that

the increase in ETF ownership is associated with lower levels of private information conveyed

to managers through stock prices. Further, Ben‐David et al. (2018) find that ETF ownership

increases the nonfundamental volatility of their underlying stocks. Finally, in this study, we

find evidence indicating that the increased investments of ETFs lead to the lower share price

informativeness of their constituent firms, that is, higher informational uncertainty, where

managers learn less information from their share prices.

3

The level of cash holdings plays a key role in the determination of firm asset structure

(Cortes, 2021). Hence, managers prefer to have sufficient information to help them identify

their firms’optimal cash holding level, which is determined based on a trade‐off between the

benefits and costs of holding cash (Keynes, 1936). Therefore, despite the opportunity cost of

holding cash, managers in firms with higher informational uncertainty, due to higher ETF

ownership, could find holding cash as precautionary savings to be less costly, avoiding dis-

tortion in their future corporate investments (Myers & Majluf, 1984; Opler et al., 1999). Based

upon these findings and in line with the precautionary motive of cash holdings, we conjecture

to find a positive relation between ETF ownership and the cash holding levels of their con-

stituent firms.

To test this hypothesis, we focus on the period from 2000 Q1 to 2019 Q4. The initial data set

from ETF ownership calculations contains 454 ETFs and 168,083 firm–quarter observations. In

further steps, we exclude financial and utility firms. We restrict our sample to firms with

headquarters in the United States. We require total assets to have a greater value than capital

expenditures and both to have positive values. We drop data where total liabilities are greater

than total assets and where the sum of long‐and short‐term debt is greater than total assets. We

also require firms to have an ETF ownership level greater than zero. This process reduces the

sample to 143,659 firm–quarter observations only for the core variables. Omitting values

missing for a small set of variables, we obtain a final sample with a full set of variables

consisting of 47,183 observations across 2461 US‐listed firms.

Our findings indicate that ETF ownership is associated with externality at the corporate

level, in that it leads the managers to learn less information from stock prices and increases the

informational uncertainty when they choose their cash holding policies. The association be-

tween ETF ownership and cash holdings is positive and significant. To allay concerns of

endogeneity concerning reverse causality and omitted variables, we test our hypothesis using

two different sets of natural experiments with instruments.

In robustness tests, we start by including several control variables to test whether our main

results hold. First, we control for other types of institutional ownership individually in our

model. In particular, we focus on active open‐end mutual funds, index open‐end mutual funds

and closed‐end mutual funds. Second, we control for other sources of public and private

3

We find evidence indicating that managers learn less from their own firms’stock prices, even when ETF prices are

available and the incremental information decreases; that is, informational uncertainty about firms’future cash flow

grows as ETF ownership increases. For more details, see Section 4.2 and Table B.1 in the online Supporting

Information Appendix.

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