The Tax Asymmetry Motive to Hold Corporate Cash

Dividends and share repurchases are taxed, but raising funds does not offer a symmetric tax advantage. Hence, it is preferable for the firm to retain cash if the funds may be needed later. The paper formalizes this cash accumulation motive in a corporate finance model that trades off the advantages of saved personal taxes against agency and corporate tax costs of keeping cash inside the firm. Calibration of the model reveals an optimal average cash level of 24% of net asset value, about half of which is explained by the tax asymmetry motive. We present empirical evidence for the tax asymmetry motive by verifying a positive relation between the effective dividend tax rate and corporate cash holdings. We also show theoretically and empirically that this motive is more important for firms with high volatility, low agency cost, and low corporate tax rates.