Do Corporations Retain Too Much Cash? Evidence from a Natural Experiment
Review of Financial Studies, forthcoming
74 Pages Posted: 21 Dec 2018 Last revised: 11 Nov 2022
Date Written: November 10, 2022
Corporations have accumulated record amounts of cash. We study whether firms' cash retention has been excessive by examining a Korean reform that introduced a new tax on earnings retained as cash. Difference-in-differences tests show that treated firms reduce cash retention and instead increase payouts and investments. Market participants react favorably to the reform, consistent with excessive cash retention. The valuation effects and the alternative uses of the cash are associated with behavioral and agency frictions. Firms that are more subject to behavioral biases increase payouts and experience higher valuations, while poorly governed firms allocate more to investment and experience relatively lower valuations.
Keywords: Corporate cash, investment, wages, payout policy, natural experiment, tax
JEL Classification: G32, G35, G38
Suggested Citation: Suggested Citation