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Corporate Governance and the Value of Cash Holdings

Amy K. Dittmar

The Stephen M. Ross School of Business at the University of Michigan

Jan Mahrt-Smith

University of Toronto - Rotman School of Management

November 2005

In this paper, we investigate how corporate governance impacts firm value by examining both the value and the use of cash holdings in poorly and well governed firms. Cash represents a large and growing fraction of corporate assets and generally is at the discretion of management. We use several measures of corporate governance and show that governance has a substantial impact on firm value through its impact on cash: $1.00 of cash in a poorly governed firm is valued by the market at only $0.42 to $0.88, depending on the measure of governance. Good governance approximately doubles this value of cash. Furthermore, governance has a significant impact on how firms use cash. We show that firms with poor corporate governance dissipate cash quickly and in ways that significantly reduce operating performance. This negative impact of large cash holdings on future operating performance is cancelled out if the firm is well governed. All of our results hold after controlling for the level of acquisitions undertaken by cash rich firms, indicating that acquisitions are not solely responsible for the value destruction in poorly governed, cash rich firms. The findings presented in this paper provide direct evidence of how governance can improve or destroy firm value and insight into the importance of governance in determining corporate cash policy.

Number of Pages in PDF File: 58

Keywords: Cash Holdings, Corporate Governance, Ownership Structure, Take-Over Provisions, Firm Value

JEL Classification: G30, G32, G34

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Date posted: March 22, 2005  

Suggested Citation

Dittmar, Amy K. and Mahrt-Smith, Jan, Corporate Governance and the Value of Cash Holdings (November 2005). Available at SSRN: http://ssrn.com/abstract=687464 or http://dx.doi.org/10.2139/ssrn.687464

Contact Information

Amy Dittmar
The Stephen M. Ross School of Business at the University of Michigan ( email )
701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-764-3108 (Phone)
HOME PAGE: http://webuser.bus.umich.edu/adittmar/
Jan Mahrt-Smith (Contact Author)
University of Toronto - Rotman School of Management ( email )
105 St. George Street
Toronto, Ontario M5S 3E6
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References:  43
Citations:  231

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