The trade openness and corporate cash holdings: evidence from the establishment of Chinese Free Trade Zones

We investigate whether trade openness influences corporate cash holdings by exploiting the establishment of Chinese Free Trade Zones (FTZs) as a quasi-natural experiment. Our results show that firms located in FTZ cities maintain significantly lower cash holdings than comparable firms in non-FTZ cities, consistent with the hypothesis that the establishment of FTZs reduces corporate cash holdings. Further analysis identifies two mechanisms: FTZs reduce financial constraints and enhance firms’ transaction liquidity. By improving firms’ access to external finance, FTZs reduce the need to retain cash for precautionary purposes. At the same time, enhanced liquidity enables firms to convert assets into cash more quickly, thereby lowering the amount of cash required for transactions needs. These mechanisms weaken both the precautionary and transaction motives for holding cash. The effect is more pronounced among firms with higher overseas sales and among those whose managers exhibit greater aversion to uncertainty. Moreover, firms located in FTZ cities increase investment in physical assets while reducing investment in financial assets. Overall, our findings suggest that institutional innovations reshape the business environment and motivate firms to hold less cash in anticipation of improved investment opportunities.