Value of Cash Holdings and Accounting Conservatism

Abstract

We posit that accounting conservatism could mitigate the value destruction associated with increases in cash holdings. Consistent with this conjecture, we find that the market value of an additional dollar in cash holdings increases in accounting conservatism. This result is robust to controlling for strength of corporate governance, earnings quality, past stock performance, potential unobserved firm heterogeneity, potential endogenous changes in conservatism, and other relevant variables. Overall, the evidence suggests that accounting conservatism is associated with a more efficient use of cash holdings, supporting the notion that accounting conservatism can serve as a substitute for external monitoring and reduce agency conflicts between managers and shareholders.

Keywords: Cash holdings, Accounting conservatism, Agency costs

JEL Classification: M41, G30, G32