Value of Cash Holdings and Accounting Conservatism
Posted: 23 Aug 2011 Last revised: 25 Aug 2015
Date Written: August 23, 2011
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. Most of the discussion about conservatism in the literature is about its role in mitigating conflicts of interest between owners/managers and debtholders and in reducing the cost of debt. Our analysis suggests that accounting conservatism also mitigates agency costs related to incentive conflicts between shareholders and managers by inducing a more efficient use of cash holdings by managers, thereby providing direct benefits to shareholders. The notion that accounting conservatism would reduce managers’ incentives to engage in value-destroying projects has long been suggested in the literature. However, our study is the first to empirically establish that accounting conservatism increases the value of cash holdings. This evidence is particularly important in light of the tremendous growth in cash holdings in the U.S. in recent years (Bates, Kahle, and Stulz 2009) and the massive value losses that can result from cash holdings (Jensen and Walkling 2010).
Keywords: Cash holdings, Accounting conservatism, Agency costs
JEL Classification: M41, G30, G32
Suggested Citation: Suggested Citation