INTRODUCTION
1.1
Background
of the Study
Adetifa (2012) submits that cash holding is
cash in hand or readily available for investment in physical assets and to
distribute to investors. Cash holding is therefore viewed as cash or cash
equivalent that can be easily converted into cash. In this context, cash
holding will include cash in hand and bank, short time investment in money
market instrument such as treasury bills. Owing to the significance of cash and
its importance in working capital management, different approaches are being
used to determine factors that influence it. Marsh (2009) states that holding
cash is at a cost, which is the opportunity cost of the capital invested in
liquid assets. The potential profit forgone on holding large cash balance is an
opportunity cost to the firm. Alam, Ali, Rehman and Akram (2011) asserts that
the costs of cash holding are of two categories: cost of excessive cash holding
such as opportunity cost of interest foregone, costs of purchasing power among
others and cost of inadequate cash holding including cost of corporate image,
loss of cash discount on purchases and loss of business opportunities.
The corporate cash holding determinants have
since been a subject of explanation in the framework of three theories, namely:
the Trade-off Model, Pecking Order Theory and Free Cash Flow Theory. According
to trade-off theory, they set their optimal level of cash holding by weighing
the marginal costs and marginal benefits of holding cash (Almeida, Campello and
Weisbach, 2009). The main advantages associated with cash holding include reduction
in the likelihood of financial distress, pursuance of the optimal investment
policy even when financial constraints are met, and its contribution to
minimize the costs of raising external funds or liquidating existing assets.
Chen and Mahajan (2010) state that the
benefits of cash holding are: i) reduction in the likelihood of financial
distress, ii) allowing the pursuance of investment policy when financial
constraints are met, and iii) minimizing the costs of raising external funds or
liquidating existing assets.As per the pecking order theory, firms finance
investments firstly with retained earnings, then with safe debt and risky debt,
and finally with equity (Tuller, 2008). When current operational cash flows are
sufficient enough to finance new investments, firms repay debt and accumulate
cash. When retained earnings are not enough to finance current investments,
firms use the accumulated cash holdings and, if needed, issue debt while free
cash flow theory as explained by Pandey, (2010) that managers have an incentive
to hoard cash to increase the amount of assets under their control and to gain
discretionary power over the firm investment decision. With the cash holding,
they do not need to raise external funds and could undertake investments that have
a negative impact on shareholders’ wealth.
The fallout of his submission has foreclosed
the necessity of maintaining optimum cash holding.Van-Horne (2012) emphasizes
that firm should maintain optimum cash holding. He also maintained that how to
determine the optimum cash holding is a major concern for the financial manager
globally, Nigeria inclusive.
Efforts
have been on to identify what are the determinants of cash holding bearing in
mind the bank’s characteristics such as size, loans to deposit ratio, liquidity
ratio, bank deposit liability. Hence, this study evaluates bank-specific
determinants of cash holding in Nigeria commercial banks.
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