This paper uses a set of natural experiments in U.S. patent legislation to explore how changes in growth opportunities translate into adjustments of cash- and payout policy. When faced with a value-decreasing shock to their portfolio of growth options, firms respond by reducing their cash holdings. They do so primarily through increased payouts, and in particular, repurchases of stock. This is good news in light of agency theories of free cash flow, as it suggests that managers return cash to shareholders when investment opportunities decline. On the other side, when a firm's growth opportunities improve, managers respond by increasing their cash balances alongside their spendings for research and development. These increases seem to be partly funded by significant equity issuing. Overall, this paper argues that the precautionary motive plays a central role for cash policy decisions of growth firms.
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