Over-investment, the marginal value of cash holdings and corporate governance

Chih Jen Huang · Tsai‐Ling Liao · Yu‐Shan Chang

22 citations0/0 files storedStudies in Economics and Finance

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Corporate Finance and Governance Financial Markets and Investment Strategies Working Capital and Financial Performance

Abstract

Purpose – The purpose of this paper is to examine how investors’ valuation of cash holdings is related to firm-level investment. Design/methodology/approach – As prior studies note that holding excess cash serve as a driver to would be over-investing, and that over-investment imposes substantial agency costs on shareholders, the authors focus on the value implications of holding cash in the presence of over-investment from the perspective of shareholders. Findings – By examining the publicly traded companies on Taiwan stock market, the authors uncover that cash is valued less in firms with over-investment than in those with under-investment and the magnitude of over-investment is negatively related to the marginal value of cash holdings (MVCH). It reveals that investment activities impact the value that shareholders place on cash holdings. Moreover, further tests indicate that higher block holdings and the presence of independent directors on boards can effectively mitigate the negative impact of over-investment on the MVCH. Practical implications – This paper enhances the understanding of the valuation implications of cash reserves held by firms with over-investment and the effectiveness of governance structures in containing the detrimental effect of investment-related agency costs on the value of holding cash. Originality/value – This paper provides pioneering evidence that outside investors discount cash assets in over-investing firms to reflect their expectations that they will not receive the full benefit of these assets; and this paper extends the literature on corporate governance by assessing the role of governance mechanisms in reversing the negative relation between over-investment and the MVCH.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1996Agency costs of free cash flow, corporate finance, and takeovers 1988Financing Constraints and Corporate Investment 1987Financing Constraints and Corporate Investment 2002Investor Protection and Corporate Valuation 1999The determinants and implications of corporate cash holdings 2002Disentangling the Incentive and Entrenchment Effects of Large Shareholdings 1990Managerial discretion and optimal financing policies

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2018Overinvestment, leverage and financial system liquidity: A challenging approach 2016Cash holdings and bond returns around takeovers 2020Influence of independent directors on the market risks of Indian banks 2021Does debt heterogeneity impact firm value? Evidence from an emerging context

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