Examining the Impact of Idiosyncratic Risk on Corporate Cash Holdings: Evidence from China

Insiders are known to trade when they believe their companies are undervalued and when they have access to confidential information regarding future cash flows. This paper investigates the impact of idiosyncratic risk on cash holdings using a dataset of Chinese-listed firms from 2008 to 2020; our empirical results reveal that cash holdings are positively correlated with idiosyncratic risk, and the mediation effect of investment is proved. We further investigate whether insiders at firms with high idiosyncratic risk (associated with financial irregularities and greater private information in prices) receive larger returns on their trades than insiders at companies with lower idiosyncratic risk based on these findings. We show that idiosyncratic risk enhances the profitability of corporate transactions (insider purchases and sales, as well as share repurchases). Corporate transactions are contrarian, and the magnitudes of returns before and after trades grow as idiosyncratic risk increases. In this study, we conduct empirical analysis in two parts. In the first phase, we look at how the level of discretionary idiosyncratic risk affects enterprises’ cash holding strategy. In the second phase, we investigate the consequences for business investments of the link between discretionary idiosyncratic risk and cash holdings.