Easy Come, Easy Go: Cheap Cash and Bad Corporate Decisions

Abstract:     
This paper investigates whether the source of firms' cash reserves can predict how they will spend them. I analyze a firm's cash holdings, creating the first dataset that organizes it by whether it comes from: Financing, Operating or Investment activities. This dataset allows me to revisit the free cash flow hypothesis. The agency problems previously associated with large cash holdings seems to apply only to firms with cash reserves coming from operations. Firms with large cash reserves coming from financing activities are less likely to make an acquisition, and, if they do, they do not destroy value. In addition, they time the market more efficiently and thus obtain higher returns on their share repurchase activities. My evidence is consistent with theories of the disciplinary effects of external financing. And it has implications for future empirical research using cash holdings, as well as for the characterization of efficient cash management.

Number of Pages in PDF File: 49

Keywords: Cash Holdings, Merger and Acquisitions, Share Repurchase, Market Timing, Cost of Capital, Agency

JEL Classification: G30, G31, G32, G34, G35

working papers series