Government debt and corporate cash holding: international evidence

This study investigates the impact of government debt on corporate cash holdings. Using data from 21 countries between 1996 and 2022, we find that elevated public debt levels motivate firms to hold more cash for precautionary purposes. To establish causality, we use the formation of the European Monetary Union (EMU) as a quasi-natural experiment and find that firms in countries integrated in the EMU exhibit a weaker sensitivity of cash holdings to government debt, consistent with the reduced uncertainty in the external environment perceived by firms under monetary integration. To further explore the mechanism, we introduce the Whited-Wu index to measure financing constraints and the Economic Policy Uncertainty Index to measure the external macro-environment of enterprises. We find that the increase in government debt does not affect corporate cash holdings by exacerbating financing constraints, but by affecting the macro-environmental uncertainty perceived by enterprises. These results provide evidence that government debt affects corporate cash policies primarily by strengthening firms’ perceptions of macroeconomic risks and fiscal uncertainty.