Judicial reform and corporate cash holdings: Evidence from the establishment of circuit courts in China

Abstract

This paper studies the effect of judicial reform on corporate cash holdings. Leveraging the establishment of Circuit Courts in China as an exogenous shock, we demonstrate that firms reduce cash holdings by 10.4% when under the jurisdiction of a court. The two primary channels through which the courts affect cash holdings are the availability of cheaper external financing and lower litigation uncertainty. This effect is more pronounced in financially constrained, private, and non-politically connected firms. Moreover, the equivalent perceived value of one additional CNY of cash held by firms declines by ￥0.091 due to lower precautionary motives. Further analysis shows that firms are more likely to pursue returns from alternative strategies by investing more, raising more capital, and buying back more shares. Collectively, these results suggest that judicial independence can have potentially important consequences for corporate cash management strategies.