Financial Crisis, Corporate Governance and the Value of Cash Holdings

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

Abstract

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

• Item Type: MPRA Paper
• Language: English
• Keywords: Financial Crisis, Corporate Governance, Cash, Leverage, Pledgeable Assets
• Subjects: G - Financial Economics > G0 - General > G01 - Financial Crises; G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; G - Financial Economics > G3 - Corporate Finance and Governance > G30 - General; G - Financial Economics > G3 - Corporate Finance and Governance > G31 - Capital Budgeting ; Fixed Investment and Inventory Studies ; Capacity; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G3 - Corporate Finance and Governance > G35 - Payout Policy

References

Acharya, V.V., Almeida, H. and Campello, M., 2007. Is cash negative debt? A hedging perspective on corporate financial policies. Journal of financial intermediation, 16(4), pp.515-554.

Acharya, V. V., Davydenko, S. A., and Strebulaev, I. A. (2012). Cash holdings and credit risk. Review of Financial Studies, 25(12), 3572-3609.

Almeida, H. and Campello M. (2007). Financial constraints, asset tangibility, and corporate investment. Review of Financial Studies, 20(5), 1429-1460.

Almeida, H. Campello, M. and Weisbach, M. S. (2004). The cash flow sensitivity of cash. The Journal of Finance, 59(4), 1777-1804.

Almeida, H., Campello, M., Cunha, I. and Weisbach, M.S., 2014. Corporate liquidity management: A conceptual framework and survey. Annu. Rev. Financ. Econ., 6(1), pp.135-162.

Baker, M. and Wurgler, J. (2002). Market timing and capital structure. The journal of finance, 57(1), 1-32.

Bates, T. W., Kahle, K. M., and Stulz, R. M. (2009). Why do US firms hold so much more cash than they used to?. The journal of finance, 64(5), 1985-2021.

Bebchuk, L., Cohen, A., and Ferrell, A. (2009). What matters in corporate governance?. Review of Financial studies, 22(2), 783-827.

Campello, M., Graham, J. R., and Harvey, C. R. (2010). The real effects of financial constraints: Evidence from a financial crisis. Journal of financial Economics, 97(3), 470-487.

Dittmar, A.and Mahrt-Smith, J. (2007). Corporate governance and the value of cash holdings. Journal of financial economics, 83(3), 599-634.

Carpenter, R. E. (1995)}. Finance constraints or free cash flow?. Empirica, 22(3), 185-209.

DeMarzo, P., and He, Z. (2016).} Leverage dynamics without commitment (No. w22799). National Bureau of Economic Research.

Devereux, M. and Schiantarelli, F., 1990. Investment, financial factors, and cash flow: Evidence from UK panel data. In Asymmetric information, corporate finance, and investment (pp. 279-306). University of Chicago Press.

Dittmar, A., Mahrt-Smith, J., and Servaes, H. (2003). International corporate governance and corporate cash holdings. Journal of Financial and Quantitative analysis, 38(01), 111-133.

Duchin, R., Ozbas, O., and Sensoy, B. A. (2010). Costly external finance, corporate investment, and the subprime mortgage credit crisis. Journal of Financial Economics, 97(3), 418-435.

Dyck, A. and Zingales, L. (2004). Private benefits of control: An international comparison. The Journal of Finance, 59(2), 537-600.

Easterbrook, F. H. (1984). Two agency-cost explanations of dividends. The American Economic Review, 74(4), 650-659.

Erkens, D. H., Hung, M., and Matos, P. (2012). Corporate governance in the 2007–2008 financial crisis: Evidence from financial institutions worldwide. Journal of Corporate Finance, 18(2), 389-411.

Fazzari, S. M., Hubbard, and R. G., Petersen, (1988). Finance constraints and corporate investment. Brookings papers on economic activity, 1988(1), 141-206.

Faulkender, M. and Wang, R. (2006). Corporate financial policy and the value of cash. The Journal of Finance, 61(4), 1957-1990.

Frazer Jr, W. J. (1964). The financial structure of manufacturing corporations and the demand for money: Some empirical findings. Journal of Political Economy, 72(2), 176-183.

Froot, K. A., Scharfstein, D. S., and Stein, J. C. (1993). Risk management: Coordinating corporate investment and financing policies. the Journal of Finance, 48(5), 1629-1658.

Gompers, Paul, Joy Ishii, and Andrew Metrick (2003). Corporate governance and equity prices. The quarterly journal of economics 118, no. 1 (2003): 107-156.

Gorton, G., 2008. The panic of 2007. Yale School of Management, Unpublished working paper.

Greenlaw, D., Hatzius, J., Kashyap, A. K., and Shin, H. S. (2008). Leveraged losses: lessons from the mortgage market meltdown. In Proceedings of the US monetary policy forum.

Han, S. and Qiu, J. (2007). Corporate precautionary cash holdings. Journal of Corporate Finance,

Harford, J., Mansi, S. A., and Maxwell, W. F. (2012). Corporate governance and firm cash holdings in the US. In Corporate Governance (pp. 107-138). Springer Berlin Heidelberg.

Jensen, M.C., 1986. Agency costs of free cash flow, corporate finance, and takeovers. The American economic review, 76(2), pp.323-329.

Jensen, M.C. and Meckling, W.H., 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of financial economics, 3(4), pp.305-360.

Kaplan, S. N., and Zingales, L. (2000). Investment-cash flow sensitivities are not valid measures of financing constraints. The Quarterly Journal of Economics, 115(2), 707-712.

Kashyap, A. K., Lamont, O. A., and Stein, J. C. (1994). Credit conditions and the cyclical behavior of inventories. The Quarterly Journal of Economics, 109(3), 565-592.

Keynes, J. M. (1936). The general theory of employment, money and interest. Harcourt Brace. London.

Kim, C. S., Mauer, D. C. and Sherman, A. E. (1998). The determinants of corporate liquidity: Theory and evidence. Journal of financial and quantitative analysis, 33(03), 335-359.

Kiyotaki, N., and Moore, J. (1997). Credit cycles. Journal of political economy, 105(2), 211-248.

Kwan, S. H. (2010). Financial crisis and bank lending. DIANE Publishing.

Leary, M. T., and Roberts, M. R. (2010). The pecking order, debt capacity, and information asymmetry. Journal of financial economics, 95(3), 332-355.

Leland, H. E., and Toft, K. B. (1996). Optimal capital structure, endogenous bankruptcy, and the term structure of credit spreads. The Journal of Finance, 51(3), 987-1019.

Lins, K. V., and Warnock, F. E. (2004). Corporate governance and the shareholder base. Board of Governors of the Federal Reserve System.

Maggio, M. D., Kermani, A., and Song, Z. (2016). The value of trading relationships in turbulent times (No. w22332). National Bureau of Economic Research.

Moeller, S. B., Schlingemann, F. P., and Stulz, R. M. (2004). Firm size and the gains from acquisitions. Journal of financial economics, 73(2), 201-228.

Myers, S. C. (1984). The capital structure puzzle. The Journal of finance, 39(3), 574-592.

Myers, S. C. and Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of financial economics, 13(2), 187-221.

Oliner, S. D., and Rudebusch, G. D. (1992). Sources of the financing hierarchy for business investment. The Review of Economics and Statistics, 643-654.

Opler, T., Pinkowitz, L., Stulz, R., and Williamson, R. (1999). The determinants and implications of corporate cash holdings. Journal of financial economics, 52(1), 3-46.

Puri, M., Rocholl, J., and Steffen, S. (2011). Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects. Journal of Financial Economics, 100(3), 556-578.

Rajan, R. G., and Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. The journal of Finance, 50(5), 1421-1460.

Shleifer, A., and Vishny, R. W. (1992). Liquidation values and debt capacity: A market equilibrium approach. The Journal of Finance, 47(4), 1343-1366.

Shin, H. H., and Kim, Y. H. (2002). Agency costs and efficiency of business capital investment: evidence from quarterly capital expenditures. Journal of Corporate Finance, 8(2), 139-158.

Simutin, M. (2010). Excess cash and stock returns. Financial Management, 39(3), 1197-1222.

Tang, T. T. (2009) Information asymmetry and firms’ credit market access: Evidence from Moody's credit rating format refinement. Journal of Financial Economics, 93(2), 325-351

Tong, H. and Wei, S. J. (2008). Real effects of the subprime mortgage crisis: is it a demand or a finance shock? (No. w14205). National Bureau of Economic Research.

Vogt, S. C. (1994)}. The cash flow/investment relationship: evidence from US manufacturing firms. Financial management, 3-20.

Jiang, Z., and Lie, E. (2016). Cash holding adjustments and managerial entrenchment. Journal of Corporate Finance, 36, 190-205.