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Review of Quantitative Finance and Accounting

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01.08.2014 | Original Research

Investor protection and corporate cash holdings around the world: new evidence

verfasst von: Mai E. Iskandar-Datta, Yonghong Jia

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 2/2014

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Abstract

We provide new evidence that firms under weak governance regimes hold less cash than firms operating under strong governance, contrary to previous literature. Our findings also establish that there are two independent effects for the de jure and de facto aspects of governance that protect minority shareholders. Consistent with managerial empire building prediction, our study reveals that firms deplete their excess cash by overinvesting and this effect is exacerbated in countries with weak governance. The excess cash depletion has an adverse impact on firm performance, more so in countries with weak investor protection which is in support of the agency costs explanation.

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Bates et al. (2009) report that US firms’ cash holdings have doubled from 1980 to 2006 and Iskander-Datta and Jia (2012) document that this upward trend in cash reserves is also exhibited in other industrialized countries.

Deloof’s (2001) findings confirm the transaction motive for holding liquid reserves for a sample of Belgian firms.

One of the channels that the investment in real assets expands the scope and asset base of the firm is through the “asset multiplier.” When real assets increase, collateral is augmented, facilitating external financing. This in turn allows the firm to make more investments.

Total US firm-year observations are 52,264, accounting for 45 % of total observations for all other countries. Another rationale for excluding US firms is the fact that the market for corporate control in the US is strongest among all countries and such a powerful disciplinary mechanism can have a significant impact on managerial behavior regarding cash policy.

We rely on Industry Classification Benchmark (ICB) for industry classification which is adopted by stock exchanges representing over 65 % of world’s market capitalization. ICB has a four-tiered structure: 10 industries, 19 supersectors, 41 sectors and 114 subsectors. We use supersectors to define broad industries (excluding utilities and financial services).

Our firm-level data are qualitatively consistent with previous studies (Dittmar et al. 2003; Kalcheva and Lins 2007).

Both indices are based on six shareholder rights: (1) whether the law allows shareholders to vote by mail, (2) whether shares have to be deposited prior to the general shareholders’ meeting, (3) whether the law allows cumulative voting or proportional representation of minorities on the board, (4) whether an oppressed minorities’ mechanism is in place, (5) whether shareholders have pre-emptive rights, and (6) whether the minimum capital to call for an extraordinary meeting is greater than 10 %.

We also employ another potential proxy for capital market breadth, namely, the number of firms in a country. Our findings remain unchanged when utilizing this variable.

Our results contrast with Lee and Lee (2009), perhaps because they investigate internal governance structure (rather than external governance) and its impact on cash holdings.

Our findings are in line with evidence in Cheng et al. (2006) who find that stronger shareholder rights regimes are associated with lower cost of equity capital.

The index, which ranges from 0 to 4, is comprised of four creditor rights variables. These four variables include whether the reorganization procedure imposes an automatic stay on firm assets, whether secured creditors are paid first, whether creditor consent is needed to file for reorganization, and whether management can stay during reorganization. The higher the number on this index, the greater is the creditors’ power in case of default.

If we include the US in the sample and replicate the regression analysis of Model 5 in Table 1, the coefficient on revised anti-director rights index is still positive and significant at 10 % level.

We do not examine capital expenditures and R&D expenses separately because the accounting rules to expense or capitalize R&D expenses varies across countries (Flower and Ebbers 2002).

We examine the relation between governance metrics, excess cash and dividend policy and find no significant difference in change in dividend policy across high and low investor protection countries when firms hold excess cash. One possible explanation is that share repurchases have become an increasingly important payout method and have served as a substitute for dividend payout in recent years in wealthy common law countries. However, share repurchases are viewed as illegal and are heavily taxed in some civil law countries (La Porta et al. 2000a). Thus, the use of cash dividend payout may bias against finding a difference between the two regimes.

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Titel: Investor protection and corporate cash holdings around the world: new evidence
verfasst von: Mai E. Iskandar-Datta
Yonghong Jia
Publikationsdatum: 01.08.2014
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 2/2014
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-013-0371-y

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