Interaction of Trade-Off and Pecking Order Theories in Explaining the Asymmetry of Cash Adjustment Speed

Maintaining non-optimal amounts of cash has negative financial consequences for a firm. Therefore, managers target an optimal ratio for cash and strive to achieve that target. However, the speed of adjustment towards the target depends on the position of the actual cash ratio (higher or lower than the target) and the firm’s exposure to the financial deficit and surplus. The purpose of this study is to provide evidence for the asymmetry of adjustment speed.

In this research, using 3764 firm-years data from firms listed in Tehran Stock Exchange during 2002-2019 in the form of an unbalanced panel data and using the dynamic panel data method with the system generalized method of moment (System-GMM), the research hypotheses have been tested.

Findings show that compared with other firms, firms that hold cash above the target level or are in financial deficit, have a higher speed of adjustment. The supplementary results using difference generalized method of moment (Difference GMM), and a different definition to determine the financial deficit and surplus are consistent with the main

The results confirm that the cost of holding cash more than the target (in deficit firms) is more than the cost of maintaining cash less than the target (in surplus firms) and this causes firms that hold cash more than the target (in a state of financial deficit) to have a faster adjustment speed. The research findings which indicate a kind of asymmetry in cash adjustment speed reveal the interaction of Trade-off and Pecking order theories in explaining the above asymmetry.

By providing empirical evidence, this study has tried to reveal the interaction between the Trade-off and Pecking order theories in explaining the above asymmetry. The research findings contribute to the literature and theories on cash holding.