Corporate Financial Policy and the Value of Cash

By Michael W. Faulkender, Rong Wang. 2004

1,623 citations recorded by the source corpus.

We examine the cross-sectional variation in the marginal value of corporate cash holdings that arises from differences in corporate financial policy. We begin by providing semi-quantitative predictions for the value of an extra dollar of cash depending upon the likely use of that dollar, and derive a set of intuitive hypotheses to test empirically. By examining the variation in excess stock returns over the fiscal year, we find that the marginal value of cash declines with larger cash holdings, higher leverage, better access to capital markets, and as firms choose greater cash distribution via dividends rather than repurchases. WHAT VALUE DO SHAREHOLDERS PLACE ON THE CASH THAT FIRMS HOLD, and how does that value differ across firms? While an extensive literature attempts to estimate the value of adding debt to a firm’s capital structure, the search for estimates of the value of additional cash has not received nearly as much attention. This is a non-trivial oversight considering that corporate liquidity enables firms to make investments without having to access external capital markets, and to thereby avoid both transaction costs on either debt or equity issuance and information asymmetry costs that are often associated with equity issuances. Moreover, corporate liquidity reduces the likelihood of incurring financial distress costs if the firm’s operations do not generate sufficient cash flow to service obligatory debt payments. Corporate liquidity comes at a cost, however, since interest earned on corporate cash reserves is often taxed at a higher rate than interest earned by individuals. Furthermore, cash may provide funds for managers to invest in projects that offer non-pecuniary benefits but destroy shareholder value (Jensen and Meckling (1976)). Given the extent to which the literature examines the effect of these same frictions on capital structure, it is surprising that the value implications of holding cash in the presence of these frictions have not been similarly explored. 1

Subfields: Accounting, Finance, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/c0e5df2f74076cca0b78a9e5009282901035073c

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Citations in the corpus

How do managerial successions shape corporate financial policies in family firms (2011, background): “As recently argued (Denis and Sibilkov, 2010; Faulkender and Wang, 2006), liquidity holdings represent an alternative channel to ensure financial flexibility and enable firms to invest in value-enhancing projects, especially when other sources of finance are too costly or not available.”
Financial Flexibility, Investment Ability, and Firm Value: Evidence from Firms with Spare Debt Capacity (2010, background): “Faulkender and Wang (2006) find that the marginal value of cash is substantially higher for constrained than for unconstrained firms. They also report that this result is stronger for firms with high growth options. In a recent paper, Denis and Sibilkov (2010) report that higher levels of financial ”
Asset Liquidity and Stock Liquidity (2012, methodology): “To test this prediction we use the methodology in Faulkender and Wang (2006) and estimate the value of corporate cash holdings for firms with more and less liquid stock. In brief, their methodology involves regressing annual size and book-to-market adjusted abnormal stock returns on changes in cash ”
Information Asymmetry and the Value of Cash (2007, positive): “There is a growing literature that investigates the value of a marginal dollar (Pinkowitz et al., 2006; Dittmar and Mahrt-Smith, 2007; Faulkeneder and Wang, 2006).”
Determinants of corporate cash holdings: Evidence from spin-offs. (2008, background): “1 Faulkender and Wang (2006) and Pinkowitz and Williamson (2004) estimate the marginal value of a dollar of cash holdings to be approximately $0.95, and Dittmar and Mahrt-Smith (2007) document this marginal value to be even worse ($0.42) for poorly governed firms.”
Financial flexibility, corporate investment and performance: evidence from financial crises (2013, neutral): “2010) or moderate/high cash balances (Opler et al. 1999; Billet and Garfinkel 2004; Almeida et al. 2004; Acharya et al. 2007; Faulkender and Wang 2006; Dittmar and Mahrt-Smith 2007; Kalcheva and Lins 2007; Harford et al. 2008; Riddick and Whited 2008).”
International Evidence on Cash Holdings and Expected Managerial Agency Problems (2007, positive): “We can assign an economic interpretation to these coefficients along the lines of Faulkender and Wang (2006) and Dittmar and Mahrt-Smith (2007).”
Firm Cash Holdings and CEO Inside Debt (2013, methodology): “We examine the relation between the value of cash and CEO inside debt by augmenting the methodology of Faulkender and Wang (2006) to estimate the influence of CEO inside debt on the value of an additional dollar of cash to equityholders.”
The taxman cometh: Does tax uncertainty affect corporate cash holdings? (2017, positive): “…that firms hold more cash in countries with greater agency problems (Dittmar et al. 2003), cash is worth less when agency problems are more severe (Faulkender and Wang 2006; Dittmar and Mahrt-Smith 2007; Pinkowitz et al. 2006), and firms with excess cash invest in more acquisitions and those…”
What Drives Corporate Liquidity? An International Survey of Cash Holdings and Lines of Credit (2010, neutral): “Because our survey data items are limited, the variables in our models do not completely span the variables employed in prior research (see, for example, Kim, Mauer and Sherman, 1998; Opler, Pinkowitz, Stulz, and Williamson, 1999; Faulkender and Wang, 2006; Bates, Kahle, and Stulz, 2009). In particu”