Corporate Governance and Firm Cash Holdings

Abstract

We examine the relation between the management of cash holdings and corporate governance. We find that firms with weaker corporate governance have smaller cash reserves. Further tests suggest that these firms dissipate their cash reserves more quickly than do managers of firms with stronger governance, and that rather than investing internally, they spend the cash primarily on acquisitions. The investment of cash by weakly governed managers reduces future profitability, an effect that is priced into those firms' stocks. We conclude that self-interested managers choose to spend cash quickly rather than gain flexibility through stockpiling it. This suggests that the expected discipline costs of visibly accumulating excess cash reserves are high. Our results, which contrast with recent research on the cross-country relation between shareholder rights and cash holdings, help explain how country level shareholder rights interact with firm-level agency problems and shareholder power.

Keywords: Cash Holdings, Corporate Governance, Shareholder Rights

JEL Classification: G31, G34, G32, G35