Cash holdings and R&D smoothing

The sharp increase in R&D investment in recent decades has important but unexplored implications for corporate liquidity management. Because R&D has high adjustment costs and is financed with volatile sources, it is very expensive for firms to adjust the flow of R&D in response to transitory finance shocks. The main contribution of this paper is to directly examine whether firms use cash reserves to smooth their R&D expenditures. We estimate dynamic R&D models and find that firms most likely to face financing frictions rely extensively on cash holdings to smooth R&D. In particular, our estimates suggest that young firms used cash holdings to dampen the volatility in R&D by approximately 75% during the 1998–2002 boom and bust in equity issues. Firms less likely to face financing frictions appear to smooth R&D without the use of costly cash holdings. Our findings provide new insights into the value of liquidity and the financing of intangible investment, and suggest that R&D smoothing with cash reserves is now important for understanding cash management for a substantial fraction of publicly traded firms.     

Cash holdings and the bargaining power of R&D-intensive targets

Prior literature suggests that R&D-intensive firms hold large amounts of cash due to financing constraints. This paper examines whether such firms could also use cash holdings as a strategic bargaining tool in M&A transactions. Using a large sample of takeover bids announced between 1980 and 2012, we demonstrate that cash holdings positively impact R&D-intensive targets’ takeover premiums and announcement-period abnormal returns. These effects disappear in non-R&D-intensive firms. Controlling for various endogeneity and financing concerns, we also find that R&D-intensive firms build up cash holdings in anticipation of becoming a takeover target. Further analysis indicates that in R&D-intensive firms, such cash holdings are valued highly by the market. Taken together, our findings shed new light on the strategic bargaining role of corporate cash holdings in the outcomes of acquisitions targeting R&D-intensive firms.     

Stakeholder orientation and the value of cash holdings: Evidence from a natural experiment

We investigate whether and, if so, how stakeholder orientation affects the value of cash holdings by disciplining inefficient management and reducing agency costs. In so doing, we exploit the staggered enactment of constituency statutes across different states as an exogenous shock that increases the degree of stakeholder orientation substantially. Specifically, we gauge the monitoring effect of stakeholders by using the market value of cash framework of Faulkender and Wang (2006). We find that on average the marginal value of cash holdings increases significantly, both statistically and economically, after the passage of constituency statutes. The effect of constituency statutes on the value of cash holdings is stronger for firms with relatively weaker stakeholder power, high agency costs, and high information asymmetry. In subsequent tests, we show that investment efficiency in M&As and capital expenditures has improved significantly after the adoption of constituency statutes suggesting that heightened stakeholder monitoring over investments is a potential channel to enhance the value of cash holdings. Overall, our results suggest that stakeholder orientation increases the value of cash holdings by mitigating agency problems.     

CEO overconfidence and corporate cash holdings

This study proposes chief executive officer (CEO) overconfidence to be an alternative explanation to corporate cash holdings. We find positive effects of CEO overconfidence on the level of cash holdings and the value of cash, which are mainly due to the investment environments faced by firms. The positive effects of CEO overconfidence on cash holdings level and cash value are barely affected by the traditional motives of cash holdings based on trade-off and agency theories. The analysis of cash sources further explains why firms with overconfident CEOs can aggressively pursue risky investments and maintain large cash holdings at the same time. Although the prior literature indicates that overconfident CEOs tend to avoid equity issues for their capital investments, the contribution to cash savings from equity is higher than that from debt. Additional robustness tests also support our empirical findings.     

The strategic use of corporate cash holdings in collective bargaining with labor unions

We provide evidence that firms in more unionized industries strategically hold less cash to gain bargaining advantages over labor unions and shelter corporate income from their demands. Specifically, we show that corporate cash holdings are negatively related with unionization. We also find that this relation is stronger for firms that are likely to place a higher value on gaining a bargaining advantage over unions and weaker for those firms in which lower cash holdings provide less credible evidence that a firm is unable to concede to union demands. Additionally, we show that for unionized firms increases in cash holdings raise the probability of a strike. Finally, we show that unionization decreases the market value of a dollar of cash holdings. Overall, our findings indicate that firms trade-off the benefits of corporate cash holdings with the costs resulting from a weaker bargaining position with labor.     

Earnings Quality Effect on Corporate Excess Cash Holdings and Their Marginal Value

By using panel data from Korea’s listed firms, we find that firms with poor earnings quality are more likely to accumulate excess cash holdings, perhaps in an attempt to buffer themselves from information asymmetry problems. We also find that firms with poor earnings quality are more likely to discount the marginal value of their excess cash holdings because their shareholders appear to question the reason for such cash policy changes from the agency theory perspective. Overall, our results suggest that information asymmetry and agency problems are likely to co-exist in firms with poor earnings quality.     

The effect of financial constraints,investment policy,product market competition and corporate governance on the value of cash holdings

This study empirically investigates the value shareholders place on excess cash holdings and how shareholders’ valuation of cash holdings is associated with financial constraints, firm growth, cash‐flow uncertainty and product market competition for Australian firms from 1990 to 2007. Our results indicate that the marginal value of cash holdings to shareholders declines with larger cash holdings and higher leverage. However, firms that are more financially constrained, that have higher growth rates and that face greater uncertainty exhibit a higher marginal value of cash holdings. These findings are consistent with the explanation that excess cash holdings are not necessarily detrimental to firm value. Firms with costly external financing and that also save more cash for current operating and future investing needs find that the market values these cash hoarding policies favourably. Finally, there is limited evidence of an association between various corporate governance measures and the value of cash holdings for a shorter sample period.     

Governance,product market competition and cash management in IPO firms

This study evaluates the link between CEO governance heterogeneity, power structure of the firm, and product market competition on various facets of post-IPO cash policy. Our results suggest that post-IPO cash holdings as well as marginal value of cash reserves are higher under a founder CEO governance regime relative to non-founder CEOs. Concentrating board power in the hands of founder CEOs however, reduces their ability to maintain higher post-IPO cash reserves. Our results also suggest that product market competition influences both the level and marginal value of cash reserves in the hands of founder CEOs. Further, we find that stronger internal governance reduces the tendency of IPO firms to deploy excess cash reserves to fund internal investments in excess of industry rivals. Finally, our results suggest that excess cash reserves in competitive industry environments lead to superior post-IPO operating performance.     

The effect of bidder conservatism on M&A decisions: Text-based evidence from US 10-K filings

This paper examines whether and how bidders' conservative tone in 10-K filings influences the subsequent mergers and acquisitions (M&A) investment decisions of these US firms from 1996 to 2013. Based on 39,260 firm-year observations, we find, consistent with behavioural consistency theory, that conservative bidders are less likely to engage in M&A deals. Further, those that decide to engage in M&As are likely to acquire public targets and within-industry firms. These bidders are inclined to employ more stock acquisitions than cash acquisitions. Our results also indicate that conservative bidders experience abnormally poor stock returns around the announcements of M&A investments. This provides new insights on the mechanism through which bidders' sentiments influence shareholders' wealth. Overall, these findings highlight the implications of the textual sentiment of corporate disclosure for the forecasting of corporate investment and financing decisions. Our results have practical implications, since they shed light on the value relevance of the information content of major Securities Exchange Commission (SEC)-mandated 10-K filings.     

Corporate precautionary cash holdings

This paper models the precautionary motive for a firm's cash holdings. A two-period investment model shows that the cash holdings of financially constrained firms are sensitive to cash flow volatility because financial constraints create an intertemporal trade-off between current and future investments. When future cash flow risk cannot be fully diversifiable, this intertemporal trade-off gives constrained firms the incentives of precautionary savings: they increase their cash holdings in response to increases in cash flow volatility. However, there is no systematic relationship between cash holdings and cash flow volatility for unconstrained firms. We test the empirical implications of our theory using quarterly information from a sample of U.S. publicly traded companies from 1997 to 2002, and find that the empirical evidence supports our theory.     

Electronic voting in shareholder meetings and the market value of cash holdings

Electronic voting in shareholder meetings facilitates shareholders' direct monitoring by reducing the cost of attending the meetings. This study investigates how adopting electronic voting in shareholder meetings affects the market value of cash holdings. We document that the value of cash holdings is higher for firms adopting electronic voting than for non-adopting firms, especially for firms with large minority ownership and free cash flows. The increased value of cash is attributable to firms engaging in investments that are more value relevant. Collectively, the findings suggest that shareholders perceive corporate governance as strengthened with the adoption of electronic voting. This study contributes to the literature by providing initial empirical evidence on the benefits of electronic voting.     

The tax incentives and corporate cash holdings: Evidence from a quasi-natural experiment of an accelerated depreciation tax policy for fixed assets

Based on a quasi-natural experiment of an accelerated depreciation tax policy (ADP) for fixed assets in China, we examine the impact of the ADP on corporate cash holdings. Using a multiperiod difference-in-differences model with a sample of Chinese A-share listed firms from 2008 to 2020, we document that firms subject to the ADP exhibit lower cash holdings compared to firms not affected by the policy. The effect is more pronounced for young firms, profitable firms, and firms with less R&D investment. According to our mechanism analysis, the ADP mitigates a firm's financing constraints and financialization and therefore, a firm does not need as much as cash holdings as they did before the implementation of the ADP. The mechanism test results suggest that the ADP lowers the precautionary and speculative demand for cash. The analysis of economic consequences shows that the reduction of cash holdings significantly enhances firm value. Our research results suggest that the ADP is a good policy for firms.     

Managerial conservatism and corporate policies

This paper investigates how conservative managers make corporate decisions. Motivated by psychology research, we use handwritten signatures (i.e., emotionally restraint disclosure styles) as a proxy for CEO conservatism. We find that firms with conservative CEOs engage more with safer investments (capital expenditures), engage less with risky policies (Research & Development expenses and debt financing), hold more cash, are less likely to pay cash dividends, and more likely to use stock repurchase schemes. We use the same proxy for CFO conservatism. We find that CFO conservatism is a better determinant than CEO conservatism for cash holding and financing policies, but the reverse is true for investment policies. Conservative CFOs prefer long-term debt to short-term debt.     

The determinants of corporate cash management policies: Evidence from around the world

We examine the determinants of corporate cash management policies across a broad sample of international firms. We document that firms in countries with strong legal protection of minority investors are more likely to decrease their cash holdings in response to an increase in cash flow than are firms in countries with weak legal protection. This relationship is most pronounced for firms that are financially constrained and those with high hedging needs. More importantly, we do not find evidence that financial development plays an incremental impact on the cash flow sensitivity of cash, after controlling for the effect of legal protection. Therefore, we argue that the legal protection of investors (rather than financial development) represents the first-order effect in influencing international firms' cash management policies. The results are robust to alternative specifications. In general, our findings reinforce the importance of country-level legal protection of investors in mitigating the effects of firm-level financial constraints and hedging needs on corporate cash management policies.     

Share pledging,payout policy,and the value of cash holdings

Share pledging for insiders’ personal bank loans is associated with the agency problems of insider risk aversion and stock price crash risk. We examine the relation between insider share pledging and the value of cash holdings using the pledging data of listed firms in Taiwan. We find that the value of cash holdings is lower for pledging firms, especially for those that are relatively more risk averse. Pledging firms that repurchase shares have a higher marginal value of cash than those with other payout methods, likely due to the role of repurchases in reducing the stock price crash risk. Our results show how insiders’ personal financing incentives arising from share pledging would affect the value of cash holdings from the perspective of agency problems and payout policy.     

Corporate financial and investment policies when future financing is not frictionless

We study a model in which future financing constraints lead firms to have a preference for investments with shorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling [Jensen, M., Meckling, W., 1976. Theory of the Firm: managerial behavior, agency costs, and ownership structure. Journal of Financial Economics 305–360], we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.     

Labor Union Effect on Corporate Cash Holdings and Their Marginal Value

By using panel data from Korean listed firms, we find that unionized firms strategically hold less cash to enhance their bargaining power against labor unions. We also find that unionized firms are likely to reduce the marginal value of their cash holdings, thereby decreasing shareholder value from the agency theory perspective. This finding complements the agency theory argument that managers tend to waste corporate resources by hoarding cash, particularly when faced with increased information asymmetry and financial constraints. Overall, our results suggest that information-related financial constraints and agency problems are likely to co-exist in unionized firms.     

Changes in cash holdings around the S&P 500 additions

We analyze the changes in cash holding policies of S&P 500 firms from before to after their inclusion in the index. One year after inclusion, their mean industry-adjusted cash holdings decline by nearly 32% from the year before inclusion. Several factors explain this decline. The precautionary motive for cash subsides due to these firms becoming more visible, less uncertain, and less constrained to raise cheap external capital. Corporate governance deteriorates after inclusion due to increased managerial entrenchment, which leads to a reduction in cash as suggested by the free cash flow hypothesis. Most index firms face diminishing investment opportunities and decreasing capital expenditures, which implies a lesser need for cash holdings related to the transaction motive.     

Climate risk: The price of drought

We document a significant positive relation between drought risk and the cost of equity capital. Our estimation shows that the cost of equity capital is 92 basis points higher for firms affected by severe drought conditions. We provide evidence that when firms are affected by droughts, firms with higher local institutional holdings exhibit a higher cost of equity capital. This result supports the well-known local bias of institutional investors, and suggests that diversification cannot fully eliminate the loss in wealth caused by droughts. Consistent with theoretical predictions, we find that drought duration and drought intensity further increase a firm's risk premium. However, for firms with diversified cash flows/investments, geographically dispersed business operations, and high cash holdings, the impact of drought on the expected return is significantly lessened. Overall, our findings show that investors require a higher rate of returns on firms affected by droughts and offer implications on how firms can mitigate the impact of droughts on their cost of capital.     

Do REITs use cash reserves efficiently? Evidence from corporate acquisitions

We examine the combined impact of corporate governance and excess cash holdings on the propensity of firms to become bidders and engage in value destroying acquisitions. We focus on the REIT market, due to its unique characteristics caused by regulation and the nature of the industry. The lack of active real estate takeover market should lead to entrenchment and exacerbate agency costs. However, given the mandatory high cash payout for REITs, the absence of takeover market should not cause concerns to shareholders. Our analyses reveal that unlike conventional firms, cash-rich REITs are not more likely to become acquirers and acquisitions by cash-rich REITs are not value decreasing. However, similarly to industrial firms, REITs with higher excess cash and lower insider ownership are more likely to become bidders. We interpret our results to be consistent with the hypothesis that agency problems are less severe in real estate and investors are not averse to use of excess cash by REIT managers on intra-industry acquisitions.