Corporate Financial Policy and the Value of Cash

38 Pages Posted: 12 Jul 2004

See all articles by Michael W. Faulkender

Michael W. Faulkender

University of Maryland - Robert H. Smith School of Business

Rong Wang

Singapore Management University; Singapore Management University - Lee Kong Chian School of Business

Date Written: July 23, 2004

Abstract

We examine the cross-sectional variation in the marginal value of corporate cash holdings arising from differences in corporate financial policy. We begin by providing semi-quantitative predictions for the value of an extra dollar of cash depending upon whether that dollar will most likely go to i) increasing distributions to equity, ii) reducing the amount of cash that needs to be raised in the capital markets, or iii) servicing debt or other liabilities. We then relate firm financial structure characteristics to the likelihood of firms engaging in these actions, and derive a set of intuitive hypotheses to test empirically. We generate estimates of the marginal value of cash by examining the variation in excess stock returns over the fiscal year and find results that are both qualitatively and quantitatively consistent with all hypotheses tested. In particular, we find that the marginal value of cash declines with larger cash holdings, higher leverage, better access to capital markets, and as firms choose to distribute cash via dividends rather than repurchases.

Keywords: Cash holdings, financial constraints, corporate finance

JEL Classification: G32

Suggested Citation

Faulkender, Michael W. and Wang, Rong, Corporate Financial Policy and the Value of Cash (July 23, 2004). Available at SSRN: https://ssrn.com/abstract=563595 or http://dx.doi.org/10.2139/ssrn.563595

Michael W. Faulkender (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Rong Wang

Singapore Management University ( email )

Li Ka Shing Library
70 Stamford Road
Singapore 178901, 178899
Singapore

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

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