Precautionary Savings with Risky Assets: When Cash Is Not Cash

We study the investment securities that make up corporate cash holdings. Exploiting the 2009 accounting standard SFAS No. 157, which requires firms to report the composition and fair value of their financial instruments, we hand-collect detailed data on firms’ investment securities and assess their risk. Our estimates show that, on average, the value of risky securities is 27% of that of corporate cash holdings and 6% of total book assets. Contrary to the precautionary savings motive, risky security investments are concentrated in firms traditionally thought to have a high demand for precautionary savings such as firms in the technology or health industries, firms with volatile cash flows, or firms with high Tobin’s Q. Our evidence is consistent with a speculative motive for holding cash, which is particularly strong in firms with “excess” or “trapped” cash reserves, or in firms with managers who are overconfident or paid with stock options. Furthermore, we find that firms with riskier productive assets are choosing to increase the risk of their reserve assets, which is consistent with a reaching for yield explanation. We also find evidence that risky security investments are correlated with negative alphas, which shows that investors are not positively surprised by managers’ ability, or lack thereof, to create value by investing in risky assets.

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