Economic policy uncertainty and corporate cash holdings: the mechanism of capital expenditures

This study investigates the relation between economic policy uncertainty (EPU) and cash holdings in China. We find that EPU is positively related to cash holdings. Based on the mediation analysis, our results suggest that capital expenditures represent an important mechanism by which EPU affects cash holdings. However, there are two different theories to explain the mechanism of capital expenditures. Our results are consistent with the precautionary theory, but not with the real options theory. That is, reducing capital expenditures in the presence of higher EPU means weakening investment demands that, in turn, lead to fewer precautionary cash holdings.