trend is documented in all major and emerging economies.
The phenomenon of excessive piling up of
cash rather than channeling it into investments or payouts to shareholders could distort firm growth and
has implications for the aggregate economy. Consequently, examining what drives cash savings is
essential for the practice of modern corporate finance.
In this context, we focus on one of the important aspects of general corporate cash policy, the issue
of saving cash out of current cash flows. Recent studies (e.g., Bao, Chan, & Zhang, 2012; Khurana,
Martin, & Pereira, 2006; Kusnadi & Wei, 2011; Riddick & Whited, 2009), based on the work of
Almeida, Campello, and Weisbach (2004), emphasize this issue called the cash flow sensitivity of cash.
Financial market imperfections, such as asymmetric information and agency problems, limit firms’
access to external finance. Consequently, for financially constrained firms, investments are more likely
to be limited to available internal resources or cash reserves. However, saving cash today may
cause these firms to pass up current profitable investment opportunities. Hence, constrained firms
derive optimal cash policies from the trade-offs between current investments and potentially profitable
future investments. On the other hand, liquidity management is less significant for financially
unconstrained firms. Thus, understanding what drives the cash flow sensitivity of cash is important for
examining the corporate cash policies from a theoretical perspective.
In this paper, we expand that line of inquiry by studying the association between managerial social
capital and the cash flow sensitivity of cash in an international setting. Following Woolcock (1998), we
define social capital as the information, trust, and norms of reciprocity inherent in a social network.
Social capital is widely discussed in disciplines such as sociology, political science, economics, and
anthropology. There has been a recent spur in the corporate finance literature to examine the effects of
social networks on various corporate finance policies (e.g., Cohen, Frazzini, & Malloy, 2010;
Engelberg, Gao, & Parsons, 2013; Fracassi, 2017; Larcker, So, & Wang, 2013), though researchers are
reluctant to use the term ‘social capital.’The key implication underlying the theoretical view of
the cash flow sensitivity of cash is that the external financial constraint is the determining factor for the
firms’systematic efforts to save cash out of current period cash flows. We posit that managerial social
capital resident in social networks with financiers alleviates financial constraints and through that
channel reduces marginal propensity to save cash.
Social capital eases financial constraints in several ways. First, market imperfections in the form of
information asymmetry are the major impediment for the firms seeking access to outside financing
(e.g., Myers & Majluf, 1984; Rajan & Zingales, 1998; Stein, 2003). Prior research (e.g., Cohen,
Frazzini, & Malloy, 2008; Fafchamps & Minten, 1999; Faleye, Kovacs, & Venkateswaran, 2014;
Hochberg, Ljungqvist, & Lu, 2010; Hong, Kubik, & Stein, 2004, 2005; Kuhnen, 2009; Montgomery,
1991) shows that social capital through social networks opens new channels for the circulation of
information thereby reducing information asymmetry. Ferris, Javakhadze, and Rajkovic (2017)
explicitly document that social capital reduces information asymmetry, which is manifested in more
precise analysts’earnings forecasts and enhanced liquidity of well-connected firms.
Second, external financing could be prohibitively costly because of expected contracting costs
(such as search, monitoring, and contract enforcement costs). Social capital is a means of creating trust
(e.g., Dasgupta, 1988), which enables economic agents to operate efficiently and economize on
transaction costs. In addition, trust facilitates dispute resolution through voluntary cooperation within a
social network that further diminishes the expected costs of legal interventions. Finally, the risk of
managerial expropriation could also restrict firms’access to external capital. Social capital aggravates
McKinsey Global Institute (2010) −obtained from http://www.mckinsey.com/industries/private-equity-and-principal-
JAVAKHADZE AND RAJKOVIC