Corporate Governance and Firm Cash Holdings
University of Washington; Centre for International Finance and Regulation (CIFR)
Virginia Polytechnic Institute & State University
William F. Maxwell
SMU - Cox School
Journal of Financial Economics, Forthcoming
AFA 2006 Boston Meetings Paper
We examine the relation between the management of cash holdings and corporate governance. Using governance metrics based on antitakeover provisions and inside ownership, we find that firms with weaker corporate governance structures have smaller cash reserves. When distributing cash to shareholders, firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments. When investing the cash, firms with weaker governance structures increase capital expenditures more and this difference is exacerbated with higher excess cash. Similarly, we find that firms with excess cash are more likely to increase acquisition activity and this is exacerbated when the excess cash is combined with weaker shareholder rights. R&D is unrelated to excess cash in general, but is lower in firms with weak shareholder rights. We examine whether these choices are suboptimal through their impact on profitability and firm value, and document that firms with low shareholder rights and excess cash have lower profitability and valuations. However, there is little evidence that the presence of excess cash alters the overall relation between governance and profitability. Our results are consistent with the market expecting poorly governed firms to dissipate firm value through actions such as overpaying in acquisitions, rather than through future decreased profitability.
Keywords: Cash Holdings, Corporate Governance, Shareholder Rights
JEL Classification: G31, G34, G32, G35Accepted Paper Series
Date posted: May 22, 2007
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