THE JOURNAL OF FINANCE

VOL. LXV, NO. 3

JUNE 2010
Financial Strength and Product Market
Behavior: The Real Effects of Corporate Cash
Holdings
LAURENT FRESARD

ABSTRACT
This paper shows that large cash reserves lead to systematic future market share
gains at the expense of industry rivals. Using shifts in import tariffs to identify ex-
ogenous intensication of competition, difference-in-difference estimations support
the causal impact of cash on product market performance. Moreover, the analysis
reveals that the competitive effect of cash is markedly distinct from the strategic
effect of debt on product market outcomes. This effect is stronger when rivals face
tighter nancing constraints and when the number of interactions between competi-
tors is large. Overall, the results suggest that cash policy encompasses a substantial
strategic dimension.
SELDOM HAS CORPORATE strategy been turned on its head so quickly. Not long
ago, cash holdings were considered a dangerous thing to accumulate and com-
panies that hoarded large cash positions were viewed with a great deal of
suspicion.
1
However, the recent market turmoil and the resultant tightening
of credit have clearly emphasized the advantage of maintaining a liquid bal-
ance sheet, as many rms are desperately seeking to avoid a cash squeeze.
2
This rapidly changing perspective underscores the need for a deeper under-
standing of what the implications of corporate cash policy really are. Indeed,

Laurent Fr esard is fromHECParis. This paper is based onthe rst chapter of my dissertationat
the University of Neuchatel. I am extremely grateful to Michel Dubois (Chair), Francois Degeorge,
Michel Habib, Erwan Morellec, and Milad Zarin for many helpful discussions. I also thank Tom
Berglund; Francois Derrien; John Graham (the Co-editor); Rachel Hayes; Campbell Harvey (the
Editor); Uli Hege; Jean Imbs; Mesrop Janunts; Jens Martin; Sebastien Michenaud; Christophe
P erignon; Evgeny Plaksen; Gordon Phillips; Enrique Schroth; Linus Siming; Ren e Stulz; Philip
Valta; an anonymous referee; an anonymous associate editor; and seminar participants at EPFL,
Imperial College London, HEC Paris, the University of Lugano, the University of Lausanne, the
2009 Winter European Finance Conference in Klosters, the 2008 Frontiers of Finance Conference in
Belize, the 2008 Chicago Quantitative Alliance (CQA) Meeting in Chicago, the 6th Swiss Doctoral
Workshop in Finance in Gerzensee, the rst Swiss Corporate Finance Day in Neuch atel, the
2008 EFA meeting in Athens, the 2008 EFMA meeting in Athens, and the 2007 French Finance
Association Meeting in Paris for their valuable comments and suggestions.
1
See, for instance, The Corporate Savings Glut, The Economist, July 7, 2005; Behind Those
Stockpiles of Corporate Cash, by Mark Hulbert, Wall Street Journal, October 22, 2006; or Com-
panies Are Piling Up Cash, by Diana B. Henriques, The New York Times, March 4, 2008.
2
See, for example, All You Need Is Cash, The Economist, November 20, 2008; Desperately
Seeking a Cash Cure, The Economist, November 20, 2008; or the recent evidence reported by
Campello et al. (2009).
1097
1098 The Journal of Finance
R
although recent developments have considerably broadened our knowledge of
the various determinants of corporate cash holdings, the literature has so far
paid little attention to whether cash holdings have a material effect on rms
day-to-day operations. This paper helps bridge that gap by examining whether
cash holdings include a strategic dimension that affects rms product market
decisions.
Cash holdings may inuence the product market choices of a rm and its
competitors for several reasons. Chief among these reasons is the fact that a
cash-rich rm can use its war chest to nance competitive strategies. For in-
stance, a rmcan rely on a strong balance sheet to challenge rivals bottomlines
and future prospects through aggressive pricing; see Bolton and Scharfstein
(1990). A rm may also use its cash reserves to fund competitive choices, such
as the location of stores or plants, the construction of efcient distribution net-
works, the use of advertising targeted against rivals, or even the employment
of more productive workers; see Campello (2006). From a different perspective,
a rms stock of cash can signal the possibility of aggressive behavior, thereby
distorting competitors actions in the product market. Accordingly, we can view
cash holdings as a preemptive device that may affect rivals entry or capacity
expansion decisions; see Benoit (1984).
Overall, theory predicts that cash holdings may have both direct and indirect
effects on competitive outcomes. On this ground, I argue that irrespective of the
mechanism at work, if cash holdings inuence product market outcomes, then
we should observe cash-rich rms gaining market share at the expense of their
competitors. However, because a rms cash policy may be endogenously related
to its product market performance, establishing a causal link going from cash
holdings to product market outcomes is a difcult task. In this paper, I use two
different empirical strategies to side step this identication challenge. First, I
use asset tangibility to force the exogenous portion of cash to explain market
share growth. While a rms asset tangibility correlates with its cash reserves,
there is little reason to believe that the tangible attributes of a rms assets
have a direct inuence on its product market performance other than through
its association with nancing ability. Based on rm-level data from a panel of
105 well-dened product markets, instrumental variables estimates provide
strong evidence that a rms stock of cash is associated with future market
share expansion at the expense of industry rivals. More specically, rms with
noticeably higher cash reserves expand their market shares relatively more
than their competitors in future years. The estimates reveal an economically
important cash effect. Across all industries, a one-standard deviation increase
in relative-to-rivals cash holdings allows the average rm to realize a 2.9%
increase in its product market share over the next 2 years.
Second, to further mitigate concerns that product market performance drives
observed cash levels, I exploit exogenous variation in industry-level import
tariffs as a quasi-natural experiment. Since the softening of trade barriers
substantially increases the competitive pressure from foreign rivals, large re-
ductions in import tariffs represent situations in which rms have to use their
preexisting cash positions to compete in an unexpectedly modied product
Financial Strength and Product Market Behavior 1099
market environment. Difference-in-difference regressions conrm the positive
impact of cash on market share growth. Firms with more cash on hand perform
signicantly better when their industry experiences an exogenous intensica-
tion of product market competition.
3
To cement the validity of my interpretation, I offer evidence that the es-
timates truly reect the positive impact of cash reserves on product market
performance rather than biases due to the potentially unspecied effect of debt
ratios. To do so, I use the methodology developed by Acharya, Almeida, and
Campello (2007) and identify when cash is equal to, and when it is different
from, negative debt. Across various specications, I uncover a substantial im-
pact of cash on market share growth, even when cash is markedly distinct from
negative debt. This analysis highlights that the competitive effect of cash is not
the ip side of the well-documented effect of debt ratios.
4
This is an important
result given the extensive literature documenting a connection between debt
and product markets, as well as the conventional view that cash is the negative
of debt.
Next, I take advantage of the cross-industry nature of the sample to inves-
tigate how the effect of cash holdings on competitive performance depends on
industry characteristics. In particular, I explore how rivals nancial status
alters the competitive effect of cash holdings. Consistent with the idea that a
cash surplus confers a strategic advantage over cash-poor rivals, I observe that
the cash-performance sensitivity is magnied when rivals have weak nancial
positions. In a similar vein, I investigate the extent to which the competitive
effect of cash is determined by the quantity of strategic interactions between
rms within their industry. The evidence points to noticeable differential ef-
fects. In particular, the effect of cash on market share growth turns out to be
twice as large in competitive markets as in concentrated markets. Moreover,
the larger the interdependence of rm growth prospects among industry rivals,
the greater the effect of cash. In the same way, product market performance
is more sensitive to cash in sectors in which foreign competition is substantial
or when a rm operates in the technological core of its industry. Consistent
with a strategic dimension, the impact of cash holdings on product market per-
formance appears to be related to rivals nancial condition as well as to the
intensity of strategic interactions within product markets.
Finally, I examine the impact of relative cash reserves on rm value and op-
erating performance. Using various specications, I show that rms with large
cash reserves experience increases in both market value and return on assets
(ROA) in comparison with their cash-poor rivals. This result, which is robust
to the inclusion of several controls for investment opportunities, suggests that
the competitive effect of cash is value enhancing.
This paper makes two main contributions to the literature. First, by pro-
viding evidence that cash policy comprises a substantial product market
3
Note that while these results conrm that cash holdings have a causal impact on market share
growth, they cannot be interpreted as evidence that cash holdings were chosen optimally ex ante.
4
See Parsons and Titman (2008) for a survey on the relation between debt nancing and corpo-
rate strategy.
1100 The Journal of Finance
R
dimension, it deepens our understanding of the implications of cash holdings.
While previous studies nd evidence that supports a precautionary motive for
holding liquid assets, my ndings further reveal that such precautionary be-
havior turns out to bring real benets. Taken as a whole, the impact of cash
reserves on market share growth appears to be substantial and depends on both
rivals nancing and competitive conditions. As such, the strategic dimension
of cash policy needs to be taken into account when assessing the soundness of
observed cash levels and might have important implications for understanding
how rms react to credit supply shocks that restrict their access to nanc-
ing and/or governmental policies that modify the nature of their competitive
environment.
Second, this study complements recent papers that document a negative as-
sociation between debt ratios and product market performance. This result
is typically interpreted as evidence that highly indebted rms are nancially
fragile and thus can be severely affected by rivals competitive strategies. By
establishing an independent link between cash holdings and product market
outcomes, the results in this paper point to an additional channel through
which nance affects product market behavior. Importantly, the results high-
light that the connections between nancial and product market decisions are
multifaceted and suggest that cash and debt policy have distinct implications
for product market conducts. From a related perspective, this study is consis-
tent withrms integrating rivals nancial conditions and competitive positions
in their decision processes. This latter point goes in the direction of recent the-
oretical models that endogenize product market effects into optimal nancial
decisions.
5
The remainder of the paper is organized as follows. In Section I, I review
the relevant literature and develop the papers main hypothesis. Section II
describes the methodology and discusses the sample. Section III analyzes and
characterizes the impact of cash holdings on rms product market perfor-
mance. Finally, Section IV presents the papers conclusions.
I. The Setting
While much effort has recently been devoted to studying the determinants
of rms cash policies, evidence on the real implications of rms cash reserves
remains relatively scarce.
6
In particular, prior empirical work has paid lit-
tle attention to the potential effects of rms cash holdings on their actions
and performance in the product market. Yet, from an intuitive as well as a
theoretical viewpoint, the idea that rms cash reserves might affect product
market outcomes is of long standing. For instance, Tesler (1966) and more
recently Bolton and Scharfstein (1990) argue that deep-pocketed rms may in-
crease their output to drive down industry prices. To the extent that rivals face
5
See, for instance, Grenadier (2002), Novy-Marx (2007), and Morellec and Zhdanov (2008).
6
See, for instance, Blanchard, Lopez-de-Silanes, and Shleifer (1994), Harford (1999), Dittmar
and Mahrt-Smith (2007), Harford, Mansi, and Maxwell (2008), Kim, Mauer, and Sherman (1998),
or Opler et al. (1999). Bates et al. (2009) provide a comprehensive survey of this literature.
Financial Strength and Product Market Behavior 1101
difculties in accessing funds, the decrease in output price may induce losses
for nancially weak rms and drive them out of the market. Consequently, lim-
ited access to external funds can hinder a cash-poor rms ability to compete
vigorously in the product market, which may in turn prompt nancially strong
rivals to adopt predatory behaviors. Chevalier and Scharfstein (1996) also
suggest that cash-poor rms may be less inclined to invest in building market
share. In their model, rms directly decrease product prices as a means to se-
cure long-term market share instead of maximizing short-term prots. More
generally, cash holdings may be used to fund strategic practices other than
predatory pricing. Examples of such policies include decisions about capital
outlays, research and development expenses, the location of stores or plants,
distribution networks, the use of advertising targeted against rivals, the re-
cruitment of more productive workers, or the acquisition of key suppliers or
business partners (Campello (2006)). Overall, this line of research suggests
that cash-rich rms can use their war chests to nance competitive strategies
that may, in turn, enhance their performance in the product market.
From a related angle, a rms stock of cash may also inuence other players
actions indirectly. For instance, one can view cash reserves as a preemptive
weapon that may distort competitors strategies. Benoit (1984) formalizes this
idea by showing that if a potential entrant faces nancing constraints, the
threat of competitive actions by cash-rich incumbents may be sufcient to
prevent entry. Thus, by limiting entry, incumbents cash holdings can be viewed
as a driver of industry dynamics that affects rms competitive performance.
7
Similarly, cash holdings may act as a credible threat of competitive retaliation,
that is, of a second strike capability against potential capacity expansion by
industry rivals. In this spirit, a rms cash holdings may affect rivals decisions
to increase capacity and hence indirectly alter competitive outcomes.
Surprisingly, while previous theoretical work suggests both direct and in-
direct links between a rms cash reserves and product market behavior, em-
pirical assessments of the interplay between nance and the product market
concentrate mainly on linking rms competitive performance to some measure
of debt nancing.
8
According to this view, deep-pocketed rms are assumed to
be those displaying low levels of leverage. More specically, because of their
limited capacity to raise additional funds, highly indebted rms are assumed
to be nancially fragile and at risk of being severely affected by unlevered
rivals competitive strategies. Yet, recent evidence challenges this view along
several dimensions and clearly suggests a potential role for cash holdings in
explaining product market outcomes. First, Acharya et al. (2007) and Gamba
and Triantis (2008) show that cash reserves and negative debt (debt capacity)
7
In a recent paper, Hege and Hennessy (2007) suggest another channel through which cash
holdings might affect entry decisions. They argue that deep-pocketed incumbents may actually
prompt entry by increasing creditors recovery in liquidation, thereby providing potential entrants
with funds.
8
While some studies report that high indebtedness leads to poor performance in the product
market (e.g., Chevalier (1995), Phillips (1995), Kovenock and Phillips (1997), Zingales (1998),
Khanna and Tice (2000), and Campello (2003)), others nd that debt increases rms aggressiveness
in product market competition (e.g., Campello (2006), Lyandres (2006)).
1102 The Journal of Finance
R
are not equivalent when there is uncertainty about future cash ow. In this
case, different combinations of cash and debt may have different effects on rm
value and performance. This work draws attention to the fact that when exter-
nal nance is costly, cash should not be considered as the opposite of debt. In
such a context, it is likely that cash and debt play distinct roles in inuencing
competitive outcomes.
Second, recent studies suggest that the supply of capital has important impli-
cations for corporate capital structure. In particular, Faulkender and Petersen
(2006) show that, all else equal, rms that have access to the public bond mar-
ket are more levered. Their results therefore suggest that a lowlevel of leverage
may not necessarily indicate high debt capacity but may instead be a sign of
saturated debt capacity. The same intuition prevails in the work of Lemmon
and Roberts (2007) and Su (2009). Under such circumstances, a low level of
leverage may not be an accurate proxy for nancial strength.
Third, a number of studies show that corporate liquidity is empirically asso-
ciated with business risk. In particular, Opler et al. (1999) and Bates, Kahle,
and Stulz (2009) document that rms with riskier cash ow and limited access
to external capital hold more cash. Looking at the inuence of product mar-
ket dynamics on cash policy, Haushalter, Klasa, and Maxwell (2007) document
that the level of cash is positively associated with proxies for predation risk.
Nevertheless, they remain silent on the product market consequences of cash
policy.
In all, both theoretical works and empirical evidence clearly suggest that
corporate cash holdings may play an important role in explaining observed
product market outcomes. In this paper, I build on these nding by empirically
examining whether and, if so, how cash holdings affect a rm and its rivals
competitive behavior. Below, I provide compelling evidence of a causal link
going from cash holdings to product market performance and hence conrm
that cash policy encompasses a strategic dimension.
II. Methods and Data
A. Measuring the Impact of Cash on Product Market Outcomes
To explore the interplay between cash holdings and product market out-
comes, I investigate the link between cash and market share growth. I argue
that irrespective of the mechanism at work, if cash holdings include a valuable
strategic component, they will ultimately be reected in rms performance
in their product markets. I therefore examine whether rms with large cash
reserves expand their market shares more than their industry rivals. To do so,
I follow Campello (2003, 2006) and specify the following baseline model:
9
MarketShares
i,t
=
i
+
t
+(zCash
i,t2
) +

X
i
+
i,t
, (1)
9
Note that this empirical specication is very similar to those of Opler and Titman (1994),
Campello (2003, 2006), Campello and Fluck (2006), and Dimitrov and Tice (2006).
Financial Strength and Product Market Behavior 1103
where the subscripts i and t represent, respectively, the rm and the (end of
the) year. The dependent variable, MarketShares, is sales growth minus its
industry-year average, so that this variable measures a rms sales growth
in relation to that of its competitors, or equivalently, is a proxy for market
share growth.
10
To reliably gauge the effects of cash holdings on market share
dynamics, I need to characterize a rms cash position compared to its rivals.
For that purpose, I follow MacKay and Phillips (2005) and standardize the
ratio of cash to total assets within each industry-year. Specically, I compute
zCash by subtracting from the cash-to-asset ratio its industry-year mean and
divide the difference by the industry-year standard deviation. The motivation
for z-scoring cash is as follows. Imagine that a rm has 5% more cash than its
average rival. Clearly, the competitive advantage contained in this deviation
is a function of the industry-year cash-to-assets dispersion. Indeed, a 5% cash
deviation in an industry in which the standard deviation is 2% is likely to pro-
vide more strategic value than in an industry with a 15% standard deviation.
Hence, I assume that the dispersion of liquid assets within an industry-year
conditions the advantage provided by a rms cash reserves.
The vector X
i
includes control variables designed to capture other direct
sources of product market performance that may directly correlate with rms
cash positions. In particular, I include rm size, past debt ratios, and past mar-
ket share growth. One- and 2-year lagged leverage mitigates the possibility
that a correlation between cash and market share growth reects the unspeci-
ed effect of capital structure, while 1- and 2-year lagged market share growth
captures the inuence of other rm characteristics that may have driven com-
petitive performance in the recent past, such as a change in store location or
distribution network.
11
Finally, I account for time-invariant rm heterogeneity
and a time trend by including a vector of rm xed effects as well as time dum-
mies (
i
and
t
). I adjust the estimates standard errors for within-rm-period
error clustering and heteroskedasticity; see Petersen (2009).
In estimating equation (1), my primary interest is in the sensitivity of market
share growth to relative-to-rivals lagged cash holdings (). Even though this
measure is too general to pin down the specic channels through which cash
holdings shape product market actions, it summarizes relevant information
from the combination of direct and indirect strategic effects and is available for
a large cross-section of industries.
B. Identication
There are two possible sources of endogeneity bias in specication (1) that
make it challenging to identify a causal link going from cash holdings to
product market performance. First, cash policy may be endogenous to indus-
try structure. Hence, while a positive association between cash and future
10
Note that all the results in this paper hold if I consider changes in the percentage of a rms
sales of its total industry sales to measure market share growth.
11
In the following analysis, I further discuss and present evidence that the effect of cash is not
a by-product of the effect of debt levels.
1104 The Journal of Finance
R
market shares may indicate that high cash holdings allow rms to gain market
share, it may also arise if market share expansion drives observed cash levels.
Second, a positive correlation between cash reserves and market share growth
may arise even if there is no causal relation between them to the extent that
both a rms cash policy and its market share growth are affected by factors
that are not observable to the econometrician. In this paper, I address both
endogeneity concerns in several ways.
I begin by using two identication strategies to tackle the potential endogene-
ity of cash policy to product market structure. First, I estimate specication (1)
by using an instrumental variable (IV) approach. I include in the set of instru-
ments for cash two of its own lags as well as contemporaneous asset tangibility.
The lags of cash capture systematic differences in the levels of cash, whereas
asset tangibility forces the exogenous portion of cash to explain product market
performance. As recently reported by Capkun and Weiss (2007), cash holdings
are negatively associated with hard assets such as inventory, receivables,
and xed capital. While a rms asset tangibility may correlate with its cash
reserves, there is little reason to think that the tangible attributes of a rms
assets have a direct inuence on the rms product market performance other
than through its association with nancing ability. Hence, asset tangibility can
reasonably be regarded as exogenous to product market outcomes and thus
represents a valid instrument for cash holdings.
12
Alternatively, I use reductions in industry-level import tariffs to further pin
down the competitive effect of cash. Reductions in import tariffs decrease the
cost of entering U.S. product markets substantially and thus increase the com-
petitive pressure on domestic producers. As a result, I use these events as a
quasi-natural experiment to isolate the causal effect of cash on market share
growth. In particular, using a difference-in-difference methodology, I look at
how ex ante differences in predetermined cash holdings lead to differential
market share responses following the exogenous increase of competition trig-
gered by tariff reductions.
Arguably, although the use of instrumental variables and a quasi-natural ex-
periment mitigates concerns about endogenous cash policy, these approaches
alone do not resolve the possibility of spurious correlation due to unobservable
characteristics. Note, however, that the test design addresses this problem
in three ways. First, I include in equation (1) different control variables that
should help capture a wide range of unobservable effects. In particular, the
inclusion of rm xed effects removes omitted time-invariant rm factors that
may lead to spurious correlations between cash holdings and product market
performance. Second, as put forth by Campello (2006), the use of relative-to-
industry variables minimizes the concern of spurious correlation driven by
unobservable industry effects, since all industry-related factors are removed
from the estimates. Third, I estimate the effect of cash across different groups
that are sorted based on nancial and competitive dimensions. As it is not
12
In the analysis below, I use detailed identication tests to show that the instruments succeed
in identifying specication (1) parameters.
Financial Strength and Product Market Behavior 1105
obvious why potential omitted variables would have a stronger systematic ef-
fect on the cash-performance sensitivity across various groups, cross-sectional
contrasts should further limit the risk of spurious correlation.
13
C. Sample Construction and Industry Denition
I gather annual rm-level data from Compustats tapes over the period
19732006. I exclude rm-years for which information on sales, cash holdings,
and total assets is not available. I also eliminate observations with negative
equity, sales, or asset growth larger than 200%. I classify product markets
(industries) at the four-digit SIC level and restrict my focus to manufactur-
ing rms (20003999 SIC range). As pointed out by Clarke (1989) and Kahle
and Walking (1996), some of the three- and four-digit codes may fail to dene
sound economic markets. To minimize such concerns, I follow Clarke (1989)
and exclude four-digit SIC codes ending with zero and nine. Moreover, since
the estimations use industry-adjusted data, I restrict the sample to include
only industry-years with a minimum of 10 rms with available information on
sales, cash, and total assets. This selection procedure leaves me with a sample
of 105 four-digit industries. In the Appendix at the end of the main article,
I provide a detailed denition of the variables used in the following analysis;
descriptive statistics are available in the Internet Appendix.
14
Overall, the
variables in this study are comparable to those found in related studies, such
as Campello (2006), Acharya et al. (2007), and Bates et al. (2009).
III. Results: The Effect of Cash Holdings on Market Share Growth
A. Main Results
To estimate the baseline specication (1), I proceed in two steps. First, I ob-
tain the exogenous portion of cash holdings by regressing them on their lagged
values and asset tangibility, where tangibility is a function of receivables, in-
ventory, and xed capital dened as in Berger, Ofek, and Swary (1996). In a
second step, I z-score instrumented cash holdings and use the resulting scores
as a measure of nancial strength in the market share equation (1).
15
Table I displays the IV estimates of the effect of relative-to-rivals cash hold-
ings on market share growth. In column 1, the coefcient on zCash
t2
is signif-
icantly positive, suggesting that cash-rich rms outperform their more nan-
cially fragile rivals in the product market. In terms of economic magnitude,
all else equal, a one-standard deviation increase in cash in relation to rivals in
year t leads to a 2.9%(signicant at the 1%level) gain in market share between
years t + 1 and t + 2. In column 2, I perform a similar regression but consider
13
Zingales (1998) and Campello (2003) also highlight the use of cross-sectional contrasts in
studying the interplay between capital structure and product market performance.
14
The Internet Appendix is available at http://www.afajof.org/supplements.asp.
15
Note that the results in this paper are qualitatively similar if I directly instrument z-scored
cash instead of using this two-step procedure.
1106 The Journal of Finance
R
Table I
The Impact of Cash on Market Share Growth (Baseline Estimation)
This table presents results of panel regressions examining the effect of relative-to-rivals cash
holdings on market share growth (specication (1)). The dependent variable is MarketShares,
the annual market share growth given by industry-adjusted sales growth at time t [(Sales
t

Sales
t1
)/Sales
t1
]. Columns 1 and 2 report the instrumental variable (IV) estimates, where cash
holdings are instrumented by their lagged values and asset tangibility. IV estimations display
diagnostic statistics for instrument overidentication restrictions (p-values of J-statistics reported)
and exogeneity conditions (p-values for Durbin-Hausman-Wu reported). All variables are dened
in the Appendix at the end of the main article. The sample period is 1973 through 2006. Column
3 reports the coefcients of the rst-step estimation of cash on lagged cash and tangibility dened
as in Berger et al. (1996). The estimations correct the error structure for heteroskedasticity and
within-rm error clustering. I report t-statistics in brackets.

and

denote statistical signicance
at the 1% and 5% level, respectively.
Instrumental Variables First-Stage Estimation
(1) (2) (3)
zCash
t2
0.029

Tangibility
t
0.468

[12.42] [12.55]
zCash
t1
0.030

Cash
t1
0.550

[12.59] [21.22]
Size
t1
0.042

0.041

Cash
t2
0.077

[16.21] [15.70] [4.65]

Leverage
t1
0.006

0.007

[2.78] [3.06]
Leverage
t2
0.004

0.003

[3.52] [3.16]
MarketShares
t1
0.011

0.002
[2.05] [1.41]
MarketShares
t2
0.073

0.069

[14.16] [13.50]
Firm xed effects Yes Yes Yes
Time xed effects Yes Yes Yes
No. of Obs. 36,794 36,808 43,492
R
2
0.24 0.24 0.78
J-statistic (p-value) 0.26 0.22
Durbin-Hausman-Wu 0.01 0.03
a 1-year lag of relative-to-rivals cash instead of the previous 2-year lag. This
change has no bearing on the conclusions as we continue to observe a positive
and signicant effect of cash on future market share expansion (coefcient of
0.03 with a t-statistic over 12).
Note that the estimated coefcients on the control variables have the ex-
pected signs. In particular, we observe a negative association between 2-year
lagged leverage and future market share development (0.004 with a t-statistic
of 3.52). In essence, this result corroborates the argument that excessive debt
hurts product market performance.
16
We notice, however, that cash turns out to
16
See, for instance, Opler and Titman (1994), Campello (2003), Campello and Fluck (2006), and
Dimitrov and Tice (2006).
Financial Strength and Product Market Behavior 1107
have a markedly larger impact on future market share gains. Also, we observe
that past performance explains a large portion of current performance.
For completeness, column 3 reports the results of the rst-stage regression.
Consistent with Capkun and Weiss (2007), asset tangibility is negatively re-
lated to cash holdings. Moreover, we see that lagged cash plays an important
role in explaining observed cash levels. Also, the instruments have strong pre-
dictive power as the large R
2
suggests that the instrumental set explains a
sizeable fraction of the variation in cash holdings and hence lessens the pos-
sibility that weak instruments contaminate the inference. In further support
of the instruments, the test of overidentifying restrictions (J-statistics) cannot
reject the joint null hypothesis that the instruments are uncorrelated with the
error term and are correctly excluded from the second-stage regression.
To give additional support for this rst set of results, Table II presents addi-
tional versions of the baseline specication. I rst control for past acquisition
activity. As shown in Harford (1999), deep-pocketed rms are more likely to at-
tempt acquisitions. Hence, the above results might simply reect the fact that
cash-rich rms mechanically gain market share via external growth. Column
1 of Table II reveals that the competitive effect of cash is not altered by the in-
clusion of acquisition intensity (dollars spent on acquisitions scaled by assets).
As expected, the 1-year lagged acquisition intensity positively contributes to
market share expansion, whereas the 2-year lagged estimate shows a negative
sign. Interestingly, this negative effect is in line with Harford (1999), who doc-
uments that acquisitions by cash-rich rms are followed by abnormal declines
in operating performance. In column 2, I repeat this analysis by considering
the sales contributions of acquisitions instead of the dollar amount spent on
them. The results are virtually unchanged. I also take into account lagged
market-to-book to control for the residual effect of potential growth opportu-
nities not captured by past sales growth and leverage. Column 3 reveals that
this addition leads to similar results.
Another important issue relates to the use of z-scored cash to identify
relative-to-rivals nancial strength. Actually, the z-scoring procedure relies on
estimates of the industry-year standard deviations of the cash-to-asset ratios.
However, the requirement of a minimum of 10 observations by industry-year
induces a skewed distribution of cash-to-asset ratios for each industry-year,
which might affect the inference. I address this concern in three ways. First, in
column 4, I restrict the sample to observations from industry-years with a min-
imumof 30 rms. Next, in column 5, I avoid using standard deviation estimates
and replace z-scored cash with its industry-adjusted value. Finally, following
Campello (2006), in column 4, I consider only observations from industry-years
in which the skewness of cash-to-assets is between 1 and 1. Although these
estimations lower the number of observations considerably, these changes have
no bearing on the conclusions.
B. Cash as Negative Debt?
One potentially important concern with respect to the results in Tables I
and II is that the effect of cash on product market performance might actually
1108 The Journal of Finance
R
Table II
The Impact of Cash on Market Share Growth (Robustness)
This table presents additional results of instrumental variable regressions examining the effect of
relative-to-rivals cash holdings on market share growth (specication (1)). The dependent variable
is MarketShares, the annual market share growth given by industry-adjusted sales growth at
time t [(Sales
t
Sales
t1
)/Sales
t1
]. All variables are dened in the Appendix. The sample period is
1973 through 2006. IV estimations display diagnostic statistics for instrument overidentication
restrictions (p-values of J-statistics reported) and exogeneity conditions (p-values for Durbin-
Hausman-Wu reported). The estimations correct the error structure for heteroskedasticity and
within-rm error clustering. I report t-statistics in brackets.

and

denote statistical signicance
at the 1% and 5% level, respectively.
Additional Control Variables
No. of Firms > 30 Adj. Cash Skewness
(1) (2) (3) (4) (5) (6)
zCash
t2
0.027

0.028

0.028

0.038

0.273

0.029

[11.45] [10.09] [12.01] [9.55] [14.72] [8.28]

Size
t1
0.039

0.042

0.042

0.048

0.043

0.044

[14.65] [13.27] [16.00] [11.18] [16.46] [11.13]

Leverage
t1
0.001 0.002 0.011

0.009

0.007

0.006
[1.32] [0.96] [4.66] [2.36] [2.80] [1.69]
Leverage
t2
0.005

0.005

0.004

0.005

0.003

0.009

[2.74] [2.15] [3.67] [3.46] [3.30] [3.49]

MarketShares
t1
0.019

0.034

0.037

0.034

0.013

0.035

[3.38] [5.30] [6.85] [4.35] [2.53] [4.70]

MarketShares
t2
0.061

0.064

0.081

0.067

0.075

0.070

[11.49] [10.43] [15.40] [8.96] [14.61] [9.78]

Acquisitions
t1
0.531

[11.66]
Acquisitions
t2
0.227

[4.91]
SalesAcquisitions
t1
0.311

[10.45]
SalesAcquisitions
t2
0.059

[1.99]
Market-to-Book
t1
0.047

[8.57]
Market-to-Book
t2
0.005

[3.45]
Firm xed effects Yes Yes Yes Yes Yes Yes
Time xed effects Yes Yes Yes Yes Yes Yes
No. of Obs. 35,452 27,872 35,272 17,257 36,793 18,894
R
2
0.25 0.26 0.26 0.26 0.24 0.29
J-statistic (p-value) 0.19 0.32 0.27 0.33 0.21 0.18
Durbin-Hausman-Wu 0.01 0.00 0.01 0.01 0.02 0.02
reect the unspecied effect of debt ratios. Indeed, the bulk of the literature that
blends corporate nancing and product market decisions concentrates on the
impact of debt nancing on competitive outcomes. In particular, several recent
studies document that rms with lowdebt ratios, taken as a proxy for their debt
capacity, experience stronger product market performance than their highly
Financial Strength and Product Market Behavior 1109
indebted rivals. Combined with the common view of cash as negative debt,
this evidence raises the possibility that my interpretation is erroneous. Note,
however, that the baseline regression tackles this issue in part by specically
controlling for lagged leverage. The results of the previous section suggest
that the competitive effect of cash is not completely absorbed by that of debt
ratios.
17
To further lessen concerns related to misspecied strategic effects of
debt, I conduct a test based upon a simple argument. In essence, to the extent
that the inuence of cash on market share growth arises because cash is simply
the negative of debt, there should be no competitive effect of cash when cash
reserves are distinct from negative debt.
18
To empirically identify when cash reserves differ from negative debt, I draw
from Acharya et al. (2007) and group rms according to their a priori debt
capacity. Specically, cash is not the same as negative debt when reducing debt
today does not guarantee the ability to access similar debt conditions in the
future, that is, when debt capacity is saturated. Following their methodology, a
rms debt capacity is saturated whenit faces nancial constraints andwhenits
investment opportunities tend to arrive when cash ows are low, that is, when
hedging needs are high. To measure nancial constraints, I rank rm-years
based on their asset size and assign to the constrained (unconstrained) group
those rms that are in the bottom (top) quartile of the size distribution. I apply
a similar procedure to rank rms based on their age and payout ratio. Also,
I classify rms as nancially constrained if they never had their public debt
rated during the sample period but report positive debt.
19
Next, as a proxy for
hedging needs, for each rm-year, I compute the median 3-year-ahead industry
sales growth, and I then calculate the correlation between this measure and
the rms cash ow.
20
I thus assign to the group of high hedging needs those
rms for which the empirical correlation between cash owand industry future
sales growth is below 0.2, and to the group of low hedging needs those rms
for which this correlation is above 0.2.
21
Table III compares the differential effect of cash on market share growth
across groups of rms sorted both on measures of nancial constraints and
on measures of hedging needs. To preserve space, this table only reports
the coefcients on relative-to-rivals cash holdings. Of most interest are the
17
Note that I obtain similar results if I use net debt, computed as total debt minus cash divided
by total assets, as an alternative proxy for leverage. Consistent with the view that cash provides
a material advantage in the product market, the effect of net debt on market share growth is
markedly less negative than the effect of debt.
18
Note that the inclusion of past leverage should limit this possibility if we consider the fact
that rms with large debt ratios face limited debt capacity.
19
The reasons to rank rms based on their size, payout, and bond rating are carefully explained
in Acharya et al. (2007). I additionally use rms age to identify external capital access following
Hadlock and Pierce (2008), who suggest that age is a particularly useful predictor of nancial
constraints.
20
As explained in Acharya et al. (2007), the premise of this measure is that rms perceive
investment opportunities to be related to estimates of future sales growth in their industries and
that the estimates, on average, coincide with the ex post observed data.
21
Notably, the results still hold if I use cut-offs of 0.1 or 0.3.
1110 The Journal of Finance
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Table III
The Impact of Cash on Market Share Growth: Cash or Negative Debt
(Debt Capacity)
This table reports the estimates of zCash () from a series of instrumental variable (IV) esti-
mations of specication (1) across different groups. The dependent variable is MarketShares,
the annual market share growth given by industry-adjusted sales growth at time t [(Sales
t

Sales
t1
)/Sales
t1
]. Firms are classied on the basis of their debt capacity identied using proxies
for nancing constraints and hedging needs as in Acharya et al. (2007). All variables are dened in
the Appendix. The sample period is 1973 through 2006. The estimations correct the error structure
for heteroskedasticity and within-rm error clustering. The number of rm-year observations in
each group is in italics. t-statistics are in brackets. The standard errors for the differences between
High and Low (and Constrained and Unconstrained rms) are computed with a seemingly unre-
lated regression system that estimates industry group jointly. The last column (row) presents the
p-value associated with the F-tests that compare coefcients between High and Low (Constrained
and Unconstrained) subgroups.

and

denote statistical signicance at the 1% and 5% level,
respectively.
Financial Constraints High Low Diff. High Low
Criteria Hedging Needs Hedging Needs Hedging Needs
Firm Size
Constrained rms (Cons.) 0.056

0.044

0.00

[5.31] [3.56]
2,636 2,151
Unconstrained rms (Uncons.) 0.014

0.014 0.15
[2.46] [1.93]
3,890 2,481
Diff. Cons. Uncons. 0.00

0.01

Firm Age
Constrained rms (Cons.) 0.080

0.035

0.00

[4.99] [2.84]
2,393 3,315
Unconstrained rms (Uncons.) 0.026

0.010

0.02

[3.96] [1.99]
3,374 1,910
Diff. Cons. Unconst. 0.00

0.00

Payout Policy
Constrained rms (Cons.) 0.038

0.029

0.02

[6.18] [3.60]
7,279 4,965
Unconstrained rms (Uncons.) 0.018

0.011 0.01

[3.58] [1.82]
3,825 2,236
Diff. Cons. Uncons. 0.01

0.02

Bond Ratings
Constrained rms (Cons.) 0.032

0.031

0.17
[7.81] [5.08]
11,618 7,329
Unconstrained rms (Uncons.) 0.018

0.002 0.00

[2.43] [1.32]
2,086 1,797
Diff. Cons. Uncons. 0.03

0.00

Financial Strength and Product Market Behavior 1111

coefcients obtained for rms that are nancially constrained and have high
hedging needs, that is, rms with no debt capacity. Strikingly, we observe large
and signicantly, positive cash-performance sensitivities across the four mea-
sures of nancial constraints. The estimates range from 0.032 to 0.080 and
point to a sizeable effect of cash on market share growth for rms character-
ized by saturated debt capacity. Reassuringly, since we observe a signicant
competitive effect of cash when cash is manifestly distinct from negative debt,
the results reported in Table III dispel concerns that the competitive impact of
cash captures only the ip side of the effect of debt ratios.
22
C. Reverse Causality?
To further alleviate potential concerns about reverse causality, this section
exploits a quasi-natural experiment. Specically, I examine howrms use their
existing cash reserves to respond to unexpected variations of industry-level
import tariffs.
23
According to the vast literature on barriers to trade, the glob-
alization of economic activities and trade openness bring major changes in
the competitive conguration of industries; see Tybout (2003) for a survey. In
particular, as reported by Bernard, Jensen, and Schott (2006), the lessening
of trade barriers triggers signicant intensication of competitive pressures
from foreign rivals. As such, tariff reductions represent real-side shocks that
exogenously shift the competitive landscape of industries and hence modify the
relative attractiveness of having cash on hand.
To measure reductions in import tariffs at the (four-digit SIC) industry level,
I use product-level U.S. import data compiled by Feenstra (1996) and Feenstra,
Romalis, and Schott (2002). These data span the period 19722001 and include
67 of the 105 manufacturing industries (20003999 SIC range) in my initial
Compustat sample. For each industry-year, I compute the ad valoremtariff rate
as the duties collected by U.S. Customs divided by the Free-on-Board value of
imports. Next, to identify sizeable variation in barriers to trade, I characterize
tariff reductions in terms of the deviations in the yearly changes in tariffs from
their median level. Accordingly, a tariff cut occurs in a specic industry-
year when a negative change in the tariff rate is 2, 2.5, or 3 times larger
than its median change. Moreover, to make sure that large tariff reductions
truly reect nontransitory changes in the competitive environment, I exclude
22
Note that as expected, the cash-performance sensitivity is largely reduced when cash is not
different from negative debt. As such, the results of Table III are in line with Acharya et al. (2007).
While they identify when cash is not the negative of debt, the results in Table III provide evidence
that the inequality between cash and negative debt has real consequences for product market
outcomes.
23
Several studies that examine the effect of nancing on product market outcomes consider
shocks to either nancing conditions or the competitive environment to deal with endogeneity
concerns. Studies that consider shocks to nancing arrangements include Phillips (1995) and
Chevalier (1995), who examine competitive responses to a sharp exogenous increase in leverage
ratios. Studies that consider shocks to competitive environments include Zingales (1998), who uses
the deregulation in the trucking industry; Khanna and Tice (2000), who use the entry of Wal-Mart
in local markets; and Campello (2003), who uses changes in macroeconomic conditions.
1112 The Journal of Finance
R
tariff cuts that are followed by equivalently large increases in tariffs over the
2 subsequent years. The internet Appendix provides further details on tariff
data and presents several tests that support the validity of this experiment.
Next, to identify the effect of cash on product market performance, I estimate
the following difference-in-difference regression:
MarketShares
i,k,t
=
i
+
t
+(zCash
i,k,t2
) + CUT
k,t
+(zCash
i,k,t2
)
CUT
k,t
+

X
i,k
+
i,k,t
, (2)
where i indexes rms, k indexes the industry in which rms operate, and t
indexes the year. Similar to specication (1), the dependent variable is a proxy
for market share growth; zCash characterizes a rms cash position compared
to that of its rivals; and the set of control variables (X
i,k
) includes size, past
performance, and past leverage. The variable CUT
k,t
is a dummy variable that
equals one if industry k has experienced a tariff cut over the last 2 years (t and
t 1). Again,
i
is a vector of rm xed effects and
t
is a vector of time xed
effects. Since all the variables in specication (2) are industry adjusted, I do
not include an industry xed effect.
The coefcient of interest in equation (2) is the interaction between
zCash
i,k,t2
with CUT
k,t
(). Crucially, since tariff reductions occur in different
industries in different periods, equation (2) effectively takes as a control group
all rms operating in industries that do not experience a reduction in tariff in
year t, even if they have already experienced one or will experience one later
on. As a result, the coefcient measures the difference in cash-performance
sensitivity between rms that experience an unanticipated competitive shock
and rms that do not. To wit, following a reduction in tariffs, rms have to
use their predetermined cash holdings to compete in an exogenously modied
product market environment. As such, if cash reserves really provide a com-
petitive advantage, one should observe that the effect of cash on market share
growth is magnied in the aftermath of tariff reductions ( > 0). In contrast,
if the positive association between cash and product market performance only
arises because rms can perfectly foresee the competitive outcomes related to
their cash levels, the effect of cash on competitive performance should not be
altered by tariff reductions.
Table IV displays the estimates of the difference-in-difference regressions
for the three denitions of tariff reduction (2, 2.5, and 3 times the median
tariff change).
24
Notably, columns 1 to 3 reveal that the estimates of are
positive and largely signicant across the three tariff reduction measures. The
estimated coefcients range between 0.013 and 0.034, with t-statistics between
2.41 and 2.66. Interestingly, if we compare column 1 and column 3, we note that
the estimate of is about three times larger following very large cuts in tariff
rates. In line with the idea that cash holdings provide a substantial product
market advantage, the competitive effect of cash turns out to be amplied
24
Again, I adjust the estimates standard errors for within-rm-period error clustering and
heteroskedasticity using the approach suggested by Petersen (2009).
Financial Strength and Product Market Behavior 1113
Table IV
The Impact of Cash on Market Share Growth:
Difference-in-Difference Estimations
This table presents results of OLS difference-in-difference regressions examining the effect of
relative-to-rivals cash holdings on market share growth (specication (1)) following large reduc-
tions in import tariffs. The dependent variable is MarketShares, the annual market share growth
given by industry-adjusted sales growth at time t [(Sales
t
Sales
t1
)/Sales
t1
]. All variables are
dened in the Appendix. Tariff reductions (CUT) are dened using three different cut-offs. Speci-
cally, a tariff cut occurs when an industry-year change in tariff rate (T) is negative and 2 (columns
1 and 4), 2.5 (columns 2 and 5), and, respectively, 3 (columns 3 and 6) times larger than its median
value. For these three denitions, CUT = 1 if an industry had experienced a tariff cut in the last
two years (t and t 1). The sample period is 1973 through 2001. The estimations correct the error
structure for heteroskedasticity and within-rm error clustering. I report t-statistics in brackets.

and

denote statistical signicance at the 1% and 5% level, respectively.
CUT 2 CUT 2.5 CUT 3 CUT 2 CUT 2.5 CUT 3
med(T) med(T) med(T) med(T) med(T) med(T)
(1) (2) (3) (4) (5) (6)
zCash
t2
0.033

0.034

0.035

0.033

0.033

0.036

[9.91] [10.41] [11.07] [8.72] [9.19] [10.41]

zCash
t2
CUT
t
0.013

0.018

0.034

[2.41] [2.63] [2.66]

CUT
t
0.001 0.009 0.017
[1.20] [1.39] [1.78]
Size
t1
0.054

0.054

0.055

0.054

0.054 3 0.055

[14.16] [14.19] [12.71] [13.27] [13.30] [13.45]

Leverage
t1
0.009

0.008

0.009

0.011

0.01

0.011

[2.06] [2.54] [2.60] [2.94] [2.93] [2.99]

Leverage
t2
0.008

0.008

0.008

0.007

0.007

0.007

[5.11] [5.07] [5.08] [4.65] [4.61] [4.60]

Sales Growth
t1
0.043

0.049

0.043

0.042

0.042

0.042

[5.69] [5.72] [5.69] [5.33] [5.36] [5.35]

Sales Growth
t2
0.081

0.081

0.080

0.082

0.081

0.080

[10.88] [10.90] [10.87] [10.49] [10.51] [10.48]

zCash
t2
CUT
t1
0.001 0.008 0.013
[0.61] [1.16] [1.06]
CUT
t1
0.001 0.006 0.014
[0.26] [0.94] [1.13]
Firm xed effects Yes Yes Yes Yes Yes Yes
Time xed effects Yes Yes Yes Yes Yes Yes
No. of Obs. 20,514 20,514 20,514 17,648 17,648 17,648
0.28 0.29 0.29 0.30 0.30 0.31
No. of Tariff 317 180 43 317 180 43
cuts (CUT = 1)
when larger shocks hit rms competitive environment. Remarkably, there is
virtually no change in the coefcients on the control variables.
25
Note that if
25
Interestingly, we observe that the coefcient on CUT is not signicant. This is consistent with
the recent ndings in the literature on barriers to trade. After a reduction in tariffs, some rms
1114 The Journal of Finance
R
rms optimally anticipate tariff reductions, we would expect an effect of tariff
reductions prior to their implementation. In columns 4 to 6, I replace CUT by
its lagged value and nd no evidence in favor of an anticipated effect.
Taken together, this quasi-natural experiment mitigates concerns about po-
tential reverse causality and conrms that cash holdings are crucial for a
product market advantage. Below, I characterize the nature of this competitive
effect in more detail.
D. Characterization: Interindustry Differences
To further dissect the nature of the above results, I investigate howthe impact
of cash holdings on market share growth differs across and within industries.
In particular, I ask whether the competitive effect of cash depends on rivals
nancial conditions as well as on the quantity of interactions between rms
within their industries.
D.1. The Effect of the Average Rivals Financial Strength
I start the interindustry investigation by testing whether the impact of cash
holdings on market share gains is more pronounced in industries in which
rivals have a harder time obtaining external funds. To examine this prediction,
I measure the average rivals nancial strength using the average rmsize, age,
payout ratio, and public bond rating across industries.
26
For each year and for
each proxy, I rank the sample industries according to their average value and
assign rms from industries in the bottom and top quartiles to low and high
industries, respectively. Next, for each proxy, I estimate equation (1) across
subgroups and compare the estimates of the cash-performance sensitivities ()
across low and high industries.
27
Panel A of Table V reports which rms benet more from large cash reserves
interms of their market shares. For brevity, I only display the cash-performance
estimates. Across all specications, the effect of cash is larger when industry
rivals have weaker nancial positions. For instance, row 1 presents regres-
sion results for subgroups based on the average rivals size. A comparison of
coefcients across subgroups also shows that the sensitivity of market share
growth to cash holdings is signicantly larger in industries in which rivals
are relatively small. The coefcient on cash decreases by 66% when one moves
from small-size to large-size industries. A Wald test rejects the equality of the
will expand their domestic market share while others will lose some of their share. In line with
Bernard et al. (2006), the results indicate that the overall effect is neutral. However, the ndings in
this section indicate that the reallocation of market shares following a reduction in import tariffs
depends on rms cash position prior to the tariff reduction.
26
The results remain the same if I focus only on the period 19862006, during which time rms
bond rating are observed every year.
27
Specication (1) is estimated via a seemingly unrelated regression (SUR) system combining
the two subgroups. The Wald test of the differences between the two subgroups is obtained using
the standard errors provided by the SUR estimation.
Financial Strength and Product Market Behavior 1115
Table V
Cross-industries Impact of Cash on Market Share Growth
This table reports the estimates for zCash () from a series of instrument variable estimations of
specication (1). The dependent variable is MarketShares, the annual market share growth given
by industry-adjusted sales growth at time t [(Sales
t
Sales
t1
)/Sales
t1
]. I classify industries on
the basis of different proxies for the average rivals nancial status (Panel A) and a rms interac-
tion with its rivals (Panel B). All specications include the same set of control variables as in Table
I. In classifying industries according to Size, Age, Payout policy, Bond rating, and Correlation with
industry and Import penetration, I compute the industry-year average of those variables. Then,
Low industries are those ranked in the bottom quartile of the respective distribution and High in-
dustries are those ranked in the top quartile of the same distribution. Concerning the classication
based on Similarity of Operations, in each industry-year, I assign rms in the Low (High) group,
those for which Similarity of Operations is below their industry-year median value. All regressions
contain rm and time xed effects. The standard errors for the differences between High and Low
are computed with a SUR system that estimates industry group jointly. The last column presents
the p-value associated with the F-tests that compare coefcients between High and Lowsubgroups.
The number of rm-year observations in each group is in italics and t-statistics are in brackets.

and

denote statistical signicance at the 1% and 5% level, respectively.
Low High Diff. Low High
Panel A
Rivals size 0.047

0.016

0.01

[7.85] [4.35]
8,880 9,988
Rivals age 0.039

0.013

0.00

[5.80] [3.85]
8,659 10,158
Rivals payout policy 0.033

0.022

0.03

[5.77] [5.43]
9,358 9,807
Rivals bond rating 0.040

0.015

0.00

[7.16] [4.03]
9,382 9,882
Panel B
Industry concentration (HHI) 0.045

0.021

0.00

[8.78] [1.98]
9,006 1,672
Similarity of operations 0.018

0.028

0.02

[3.64] [5.36]
8,793 8,894
Correlation with industry 0.027

0.037

0.03

[6.40] [5.68]
8,815 7,188
Import penetration 0.034

0.041

0.06

[4.51] [4.70]
4,128 3,653
1116 The Journal of Finance
R
cash coefcient across subgroup estimations (p-value 0.001). In rows 2, 3, and
4, I obtain similar patterns when I split industry-years on the basis of rms
age, payout ratio, and public bond rating. Overall, these results support the
view that cash holdings allow rms to gain product market share, and that
the magnitude of these gains depends on competitors nancial status. In other
words, the competitive impact of cash holdings is determined jointly by the
rms and its rivals nancial strength. Interestingly, while the sensitivity of
sales performance to cash reserves is larger when rivals are nancially weak,
it is also signicantly positive in industry-years in which competitors turn out
to be nancially strong. Hence, cash holdings appear to play a systematic role
in determining rms performance in their product market.
D.2. The Effect of Industry Characteristics
Here, I take a different perspective and analyze whether the competitive ef-
fect of cash holdings depends on the quantity of strategic interactions between
rms within an industry. I use four schemes as proxies for the intensity with
which rms interact in their product market. The rst is the degree of indus-
try concentration. Following MacKay and Phillips (2005), I collect four-digit
SIC industry concentration ratios (Herndahl-Hirschman Index, HHI) from
the Census of Manufacturers for the years 1982, 1987, 1992, and 1997. Fol-
lowing the Department of Justices guidelines, I denote as concentrated those
industries for which the HHI index is greater than 1,800, and as competitive
those industries for which the index is less than 1,000.
28
As a second proxy,
I follow Haushalter et al. (2007) and employ the covariation between com-
petitors growth opportunities. To compute this measure, I draw from Parrino
(1997) and regress each rms monthly stock returns on the monthly equally
weighted market return and an equally weighted portfolio containing rms
in the same industry (excluding the rm itself). The regression coefcient on
the industry portfolio return captures the interdependence of growth options.
Acknowledging that such interdependence may change over time, I estimate
this proxy using a 36-month rolling-regression approach. The third proxy for
the interdependence between rms is whether a rm operates at the techno-
logical core of its industry or on the fringe. As in MacKay and Phillips (2005),
I dene the typical technology as the median capitallabor ratio for a given
industry-year and compute the similarity of operation as the absolute value of
the difference between a rms capitallabor ratio and the industry-year me-
dian ratio.
29
A smaller value of this proxy reects greater similarity of a rms
operation with the operations of industry rivals and therefore a higher risk of
28
In assigning rms to either concentrated or competitive markets, I use 1982 census data
for Compustat rm-scal years in the 19801984 period, and 1997 census data for rms in the
19951999 period. Hence, the use of this variable considerably restricts the size of the sample.
29
Note that the industry-year median is weighted by each rms share of industry sales and
excludes the rm itself. Furthermore, to make this variable comparable across industries, I divide
it by the industry-year range of the capital-labor ratio.
Financial Strength and Product Market Behavior 1117
losing market share. The last proxy I use is industry-level import penetration,
computed from the NBER-CES Manufacturing Industry Database for the pe-
riod 19722001. This measure is dened at the four-digit SIC level as the total
value of import divided by imports plus domestic production (shipments minus
exports).
Irrespective of the proxy, Panel B of Table V conrms that relative-to-rivals
cash holdings have a differential impact depending on the number of strategic
interactions. In particular, row 1 indicates that the importance of cash reserves
to expanding sales more than rivals is almost twice as large in competitive
markets as in concentrated markets. In row 2, we observe that the competitive
effect of cash is much larger when the rm is close to the technological core
of its product market than when it lies on the fringe. Row 3 points to similar
conclusions when the correlation of a rms stock returns with the stock returns
of its industry is used to measure the interdependence between competitors.
Row 4 shows an analogous pattern.
While Haushalter et al. (2007) show that the average rm increases its hold-
ings of cash when facing competitive risk, the analysis above provides evidence
on the effectiveness of such a hoarding strategy. In particular, the evidence
reveals that holding more cash than competitors effectively translates into bet-
ter product market performance when the interdependence among rivals is
important.
E. Impact on Firm Value and Operating Performance
The results above suggest that relative-to-rivals cash holdings are positively
related to future product market performance. In this context, how do the
competitive effects of cash affect rm value? To provide some evidence on the
valuation consequences of the cash effects, I examine how measures of market
value and operating performance are related to relative-to-rivals cash. As a
measure of market value, I use the market-to-book ratio. As a measure of
operating performance, I use ROA, dened as EBITDA divided by assets.
Table VI presents regression results of industry-adjusted market-to-book and
ROA on lagged z-scored cash holdings. To control for other sources of value be-
sides relative-to-rivals cash, I include rmsize, cash ow, investment, leverage,
and a dummy that equals one if the rm pays a dividend and zero otherwise.
Since I explain relative-to-rivals valuation, I subtract from the control vari-
ables their industry means in each year. Given that payout policy and asset
tangibility may directly affect rm value, I have to restrict the instrument
set and include only two lags of cash to compute predetermined cash hold-
ings. Moreover, I include both rm xed effects and time effects and I adjust
the estimates standard errors for within-rm-period error clustering and het-
eroskedasticity. In column 1, rm value increases signicantly in lagged zCash
(0.061 with a t-statistic of 7.18). All else equal, nancially strong rms have
higher valuations than their industry rivals. Hence, the market places a pre-
mium on rms that have more internal resources than their competitors. No-
ticeably, the economic magnitude of this premiumis signicant. Aone-standard
1118 The Journal of Finance
R
Table VI
The Impact of Cash on Firm Value and Operating Performance
This table presents results of panel regressions examining the effect of relative-to-rivals cash
holdings on rm value and operating performance. In columns 1 and 2, the dependent variable is
the (industry-adjusted) Market-to-Book ratio at time t. Incolumns 3 and 4, the dependent variable is
the (industry-adjusted) return on assets (ROA) at time t. All variables are dened in the Appendix.
The sample period is 1973 through 2006. Instrumental variable estimations display diagnostic
statistics for instrument overindentication restrictions (p-values for J-statistics reported). All
regressions contain rm and time xed effects. The estimations correct the error structure for
heteroskedasticity and within-rmerror clustering. I report t-statistics in brackets.

and

denote
statistical signicance at the 1% and 5% level, respectively.
Market-to-Book ROA
(1) (2) (3) (4)
zCash
t1
0.061

0.018

0.004

0.001

[7.18] [2.40] [3.74] [2.01]

Size
t1
0.276

0.199

0.018

0.021

[27.42] [21.95] [12.08] [17.91]

Investment
t1
0.977

0.106 0.003 0.024

[6.27] [0.76] [0.17] [1.13]
Leverage
t1
0.173

0.037 0.022

0.008
[2.79] [0.68] [2.38] [0.97]
Cash Flow
t1
0.112

0.135

0.232

0.290

[2.3] [3.22] [33.47] [12.49]

Dividend
t1
0.04 0.013 0.015

0.012

[1.87] [0.70] [4.79] [3.85]

Sales Growth
t1
0.048
[2.53]
Market-to-Book
t1
0.379

[30.01]
ROA
t1
0.277

[12.23]
No. of Obs. 33,813 32,983 34,613 34,517
R
2
0.50 0.58 0.61 0.62
J-statistic (p-value) 0.21 0.16 0.23 0.22
deviation increase in cash relative to rivals translates into a 6% increase in the
mean market-to-book ratio over the average competitor. Consistent with pre-
vious literature, the coefcients on size and leverage are negative, while those
on investment, cash ow, and the dividend dummy are positive. Similarly,
column 4 reveals that relative-to-rivals cash also enhances operating perfor-
mance. The estimates indicate a signicant effect on ROA (0.004 with a t-
statistic of 3.75).
A potential concern with the results in Table VI is that a company with a
lot of growth opportunities may hold much larger cash balances than rivals. To
further limit the potential effect of endogeneity inherent in the level of cash,
I include additional variables as proxies for rms growth options. Specically,
I introduce lagged relative-to-rivals sales growth, market-to-book, and ROA.
In columns 2 and 4, although the magnitude of the zCash coefcients declines
Financial Strength and Product Market Behavior 1119
slightly, they remain signicantly positive.
30
In particular, with the additional
control for growth options, a one-standard deviation increase in cash relative-
to-rivals yields a 1.8% value premium over the average rival.
Overall, these ndings are consistent with the hypothesis that nancial
strength contributes positively to rm value and operating performance. Al-
ternatively, the results of this section support the idea that the market prices
the expected market share gains associated with cash holdings.
IV. Conclusion
The main message of this paper is that rms cash holdings strategically
inuence product market outcomes. In particular, I provide evidence that larger
relative-to-rivals cash reserves lead to systematic future market share gains
at the expense of industry rivals. Importantly, this competitive effect of cash
turns out to be magnied when rivals face tighter nancing constraints and
when the number of strategic interactions between competitors is substantial.
Also, the analysis reveals that the competitive effect of cash contributes to an
increase in rm value and operating performance.
In a nutshell, this paper identies an important link between rms cash
holdings and their future product market performance. As such, the ndings
point to several interesting avenues for future research, three of which I outline
here. First, in this paper, I do not explore the precise channel through which
the gain in product market performance is achieved, as such analysis is beyond
the scope of the paper. In preliminary results, however, I nd that incumbents
stock of cash appears to signicantly curb the entry of potential competitors,
and distort rivals investment and acquisition decisions. Taken at face value,
these results suggest that cash policy comprises a preemptive dimension that
impacts rivals actions.
Second, my ndings emphasize that rms do not operate in isolation but
incorporate rivals nancial status and competitive position in their decision
process. Ultimately, this calls our attention to the fact that a rms product mar-
ket interactions need to be considered when investigating corporate nancial
decisions. Although this idea has emerged in recent theoretical developments,
it is fair to say that, so far, empirical evidence on product market feedback
remains scarce.
Third, the results may have implications in the context of the global nancial
crisis of 2008 and the associated recession. In two recent studies, Campello,
Graham, and Harvey (2009) and Duchin, Ozbas, and Sensoy (2008) document
that cash-poor rms have had to cut R&D, employment, and capital spending
to cope with tightening credit conditions and avoid a cash squeeze. In light of
30
Although I instrument cash by its own two lags and I control for growth opportunities (and
nd it to be positively and signicantly related to market-to-book), it is also possible that I do not
fully capture growth opportunities. Thus, we could expect to observe a positive correlation between
rm value and relative-to-rivals cash balances, but it does not necessarily follow that nancial
strength causes higher rm value.
1120 The Journal of Finance
R
this papers results, rms that managed to hoard cash before the 2008 crisis
might well benet from the nancial turmoil by gaining a leading position
in their product market, eventually becoming industry champions when the
downturn ends.
31
I look forward to additional research on these and related
questions.
Appendix: Denitions of the Main Variables
Variables Description
Total Assets Total Assets (Compustat Item 6) (in million USD)
Sales Sales (item 12).
Size Logarithm of total assets (item 6).
MarketShares Growth in sales computed as Sales
t
minus Sales
t1
divided by
Sales
t1
minus industry-year average.
Cash Cash and short-term investment (item 1) scaled by total assets.
Investment Growth in property, plant, and equipment (PPE) (item 7) computed as
PPE
t
minus PPE
t1
divided by PPE
t1
.
Age Number of years preceding the observation year that the rm has a
nonmissing stock price in the CRSP-Compustat merged database.
Leverage Long-term debt (item 9) scaled by total assets.
Bond rating Dummy variables that equal one if a rm has a public bond rated
during the sample period.
Tangibility 0.715

Receivables (item 2) plus 0.547

Inventories (item 3) plus 0.535

Fixed capital (item 8) (see Berger et al. (1996)).

Cash ow Sum of net income before extraordinary items (item 18) and
depreciation and amortization (item 14) scaled by total assets.
Market-to-book Market value of equity (item 24 multiplied by item 25) plus book
value of assets minus book value of equity minus deferred taxes
(item 6 item 60 item 74), scaled by total assets.
Capitallabor ratio Gross property, plant, and equipment (item 7) divided by the number
of employees (item 29) multiplied by 1,000.
ROA Ratio of operating income before depreciation and amortization
expenses (item 13) to total assets.
Acquisitions Amount spent in acquisitions (cash) (item 129) scaled by total assets.
SalesAcquisitions Sales contribution of acquisition (item 249) scaled by total assets.
Herndhal index (HHI) Four-digit SIC industry concentration ratios gathered in the Census
of Manufacturers (1982, 1987, 1992, and 1997 editions).
Import penetration Total value of annual imports divided by the sum of total import and
domestic production. Data are dened in Feenstra (1996).
31
Some anecdotic evidence seems to corroborate this tendency. For instance, John Chambers,
CEO of Cisco Systems, recently declared in The Harvard Business Review (November 2008) that
his rm tended to make more aggressive investments during bad times than good ones: When
rivals pulled back from Asia during the regions nancial crisis, Cisco deliberately increased its
presence, gaining a leading position it has never relinquished.
Financial Strength and Product Market Behavior 1121
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