Holdings of liquid assets, firm size and access to external financing: an analysis for the euro area

Firms hold liquid financial instruments in spite of their opportunity cost (they yield a lower return than alternative uses of the funds), for two basic reasons. First, to be able to make regular payments in the course of their ordinary business without having to liquidate other assets, so saving on transaction costs. Second, to cover themselves against the risk of an unexpected liquidity shortage, connected with unforeseen changes in cash flow, or of not being able to exploit new investment opportunities sufficiently quickly owing to a lack of funds. This saving with a precautionary motive will generally be more relevant for firms that have limited access to external financing, since other firms will be able to obtain the necessary funds on the capital markets. Given that the availability of external funds can affect firms’ decisions to invest in liquid assets, studying such decisions may help to determine whether the business sector is affected by external financing constraints and whether these affect some segments of the sector more than others. Against this background, this article analyses whether the relationship between liquidity ratios and their determinants (especially those linked to saving with a precautionary motive) differs according to the size of the firm, since this is a characteristic that, a priori, may be expected to affect the availability of external funds. In principle one would expect the access to external financing of SMEs to be more limited than that of large firms, insofar as information asymmetries between lenders and borrowers may be more significant in the case of the former. The study is based on a sample of firms from various countries that operated in the euro area during the period 1998-2005. The article is structured as follows. The second section briefly describes the historical evidence available in this area at the international level, the third section sets out the results of the study, and the fourth section summarises the main conclusions.