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Financial Crisis, Corporate Governance and the Value of Cash Holdings

Tut, Daniel (2021): Financial Crisis, Corporate Governance and the Value of Cash Holdings.

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We study how corporate governance impacts the deployment of internal capital when external financing is costly. Using the 2008 financial crisis as a quasi-natural experiment and difference-in-difference estimation strategy, we show that the propensity to invest out of pre-crisis cash reserves is highest for weakly-governed firms. Weakly-governed firms finance additional investment using short-term debt and allocate a higher fraction of post-crisis excess cash towards building up cash balances. Contrastingly, well-governed firms have a higher propensity to allocate excess cash towards increasing the value of pledgeable assets and use accumulated cash balances to reduce short-term debt financing. Well-governed firms trade-off the cost of cash holdings against the benefit of minimizing future demand for costly external financing; effectively hedging against foregoing profitable future investment opportunities. Overall, optimal amount of internal capital increases with the cost of external financing

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