Exacerbate or alleviate? Impact of economic policy uncertainty on excess cash holdings

In recent years, to address economic instability following the global financial crisis, inflationary pressures, and technological transformations, firms have embraced a cash is king conservative strategy to cope with the uncertainty. To examine the association between economic policy uncertainty and excess cash holdings while considering the endogeneity of cash holdings, this study analyzes the two-way fixed effects model and two-step SYS-GMM model. Taking into account China’s economic policy adjustments and external shocks, we selected balanced panel data from 2012 to 2022. To ensure robustness, we employed various methods, including different models (OLS, RE, TOBIT, FE controlling for provincial effects), altering dependent variable measurement indicators, sample adjustments (using manufacturing as a substitute), and considering the impact of COVID-19 (excluding 2020 and 2021). The results indicate a U-shaped association between economic policy uncertainty and excess cash holdings. Further analysis using the global, US, and Indian economic policy uncertainty index (GEPU, USEPU and IEPU, respectively) as instrumental variables in a two-stage least squares (2SLS) approach addresses the endogeneity issue, and the robustness of findings is confirmed. Additionally, the study finds that internal control, corporate governance, and total factor productivity significantly weaken U-shaped association between economic policy uncertainty and excess cash holdings. We also explored the mediation mechanism, showing that economic policy uncertainty indirectly leads to more excess cash holdings by increasing financing constraints and decreasing corporate risk-taking, providing new insights into how companies adjust financial strategies under policy uncertainty.