The Role of Cash Holdings in Corporate Misconduct

45 Pages Posted: 7 Aug 2017

See all articles by Frank M. Song

Frank M. Song

The University of Hong Kong - School of Economics and Finance

Zengyuan Sun

Xiamen University - Institute for Financial and Accounting Studies

Date Written: May 3, 2017

Abstract

We test the role of cash holdings in corporate misconduct. Consistent with the agency costs of equity overvaluation, before misconduct, investors overvalue firms’ cash holdings, and firms that commit misconduct accumulate excess cash holdings. Furthermore, consistent with the free cash flow hypothesis, the accumulated excess cash holdings at the beginning of misconduct positively predict firms’ simultaneous misconduct actions, including overinvestment decisions, the delay of bad news disclosures, and insider selling. The association of excess cash holdings with the degree of withholding bad news and insider trading occurs mainly in firms with higher managerial equity-based incentives or firms with internal control weakness. The results suggest that cash holdings are one important mechanism by which equity overvaluation leads to corporate misconduct and emphasize the importance of internal control over financial reporting in safeguarding corporate resources.

Keywords: Agency Costs of Equity Overvaluation, Agency Costs of Free Cash Flow, Excess Cash Holdings, Corporate Misconduct

JEL Classification: M41, G34

Suggested Citation

Song, Frank M. and Sun, Zengyuan, The Role of Cash Holdings in Corporate Misconduct (May 3, 2017). Available at SSRN: https://ssrn.com/abstract=3014505 or http://dx.doi.org/10.2139/ssrn.3014505

Frank M. Song

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong

Zengyuan Sun (Contact Author)

Xiamen University - Institute for Financial and Accounting Studies ( email )

Xiamen, Fujian 361005
China

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