The politics of precaution: how political uncertainty drives corporate cash holdings

Purpose This study investigates the moderating effects of political uncertainty, measured through firm-level political risk (PRISK) and country-level economic policy uncertainty (EPU), on the sensitivity of cash holdings to cash flows. The research examines how the combination of cash flows and political uncertainty affects firms' cash holding behavior. Design/methodology/approach The study utilizes a dataset of 6,412 firm-year observations across 923 publicly traded U.S. firms, covering the period from 2012 to 2021, to test the cash flow-cash holding sensitivity under varying levels of political uncertainty. To validate the findings, a series of robustness tests are conducted across different contexts and specifications. Findings Results indicate that while both cash flows and political uncertainty individually exhibit positive effects on cash holdings, their interaction effect is negative, suggesting that political uncertainty reduces the positive sensitivity of cash holdings to cash flows. EPU demonstrates a stronger impact than PRISK. This negative interaction effect remains robust across all robustness tests: when dividing the sample by ROA performance, using 2SLS with “election cycle” as an instrumental variable, comparing COVID-19 versus non-COVID periods, and examining group-affiliated versus independent firms. Research limitations/implications This study's results underline the complex interplay between political uncertainty and cash flows, which could vary across different economic contexts and periods of heightened uncertainty. Practical implications The findings suggest that firms should consider political uncertainty in their investment and financing decisions and adjust cash holdings dynamically in response to political uncertainty indicators. Originality/value This research provides unique insights into how combined political uncertainty metrics at both the firm and country levels can significantly alter the relationship between cash flows and cash holdings, with practical implications for cash management strategies.