The Determinants of Corporate Liquidity in the Netherlands

Abstract

We investigate the driving forces of corporate liquidity for a balanced panel of large Dutch non-financial firms during the period 1986-1997 using an error-correction framework. This framework allows a crucial distinction between short-run and long-run determinants of corporate liquidity. We conclude from our empirical estimates that long-run corporate liquidity targets exist and are based on a small number of firm characteristics. In the short run liquidity responds passively to exogenous shocks. The latter phenomenon is consistent both with buffer stock behaviour and pecking order theory. Passive liquidity behaviour does not extend to the long run, however. On average eighty percent of deviations from target is eliminated within one year. Overall, we conclude that the corporate liquidity ratio is an actively managed financial ratio and does not passively adjust to financial decisions taken elsewhere in the firm. Based on long run evidence, a pecking order theory of corporate liquidity holdings must be rejected.