Is cash king? Market performance and cash during a recession

- How does the stock market react to cash holdings in a recession?
- Cash is measured as cash and short term investments scaled by total assets.
- Before recession, Tobin's Q declines at 0.9 levels of cash/assets (range 0 to 1).
- After recession, Tobin's Q declines at 0.4 levels of cash (range 0 to 1).
- Penalty on market performance from cash holdings is greater during recession.

During a recession firms face a dilemma between investing cash to take advantage of emerging opportunities and holding cash to buffer against the crisis. Given this tension, we ask: Is cash king during a recession? Using a sample of publicly traded manufacturing firms between 2004 and 2010, we use peer cash holdings to instrument for cash and examine whether the curvilinear relationship between cash and stock market performance (Tobin's Q) changes during the economic crisis. We find that the before-recession benefits of cash decline at very high levels of cash holdings (.9 of total assets), whereas the during-recession benefits begin to decline at medium levels of cash holdings (.4 of total assets). Our results reveal that the nature of the curvilinear relationship between cash and market performance shifts from a diminishing returns curve before-recession to a more pronounced inverse U-shaped relationship during-recession.