https://faculty.fuqua.duke.edu/~jgraham/website/SurveyPaper.PDF

The theory and practice of corporate finance: Evidence from the field

https://sites.temple.edu/lnaveen/files/2014/05/JFE_risktaking_2006.pdf

Managerial incentives and risk-taking ☆

We collect detailed qualitative information from financial filings to categorize financial constraints for a random sample of firms from 1995 to 2004. Using this categorization, we estimate ordered logit models predicting constraints as a function of different quantitative factors. Our findings cast serious doubt on the validity of the KZ index as a measure of financial constraints, while offering mixed evidence on the validity of other common measures of constraints. We find that firm size and age are particularly useful predictors of financial constraint levels, and we propose a measure of financial constraints that is based solely on these firm characteristics.

New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index

We model a firm’s demand for liquidity to develop a new test of the effect of financial constraints on corporate policies. The effect of financial constraints is captured by the firm’s propensity to save cash out of cash flows (the cash flow sensitivity of cash). We hypothesize that constrained firms should have a positive cash flow sensitivity of cash, while unconstrained firms’ cash savings should not be systematically related to cash flows. We empirically estimate the cash flow sensitivity of cash using a large sample of manufacturing firms over the 1971 to 2000 period and find robust support for our theory. TWO IMPORTANT AREAS OF RESEARCH in corporate finance are the effects of financial constraints on firm behavior and the manner in which firms perform financial management. These two issues, although often studied separately, are fundamentally linked. As originally proposed by Keynes (1936), a major advantage of a liquid balance sheet is that it allows firms to undertake valuable projects when they arise. However, Keynes also argued that the importance of balance sheet liquidity is influenced by the extent to which firms have access to external capital markets (p. 196). If a firm has unrestricted access to external capital— that is, if a firm is financially unconstrained—there is no need to safeguard against future investment needs and corporate liquidity becomes irrelevant. In contrast, when the firm faces financing frictions, liquidity management may become a key issue for corporate policy. Despite the link between financial constraints and corporate liquidity demand, the literature that examines the effects of financial constraints on firm behavior has traditionally focused on corporate investment demand. 1 In an influential paper, Fazzari, Hubbard, and Petersen (1988) propose that when firms face financing constraints, investment spending will vary with the availability of internal funds, rather than just with the availability of positive net present

http://people.stern.nyu.edu/eofek/PhD/papers/ACW_Cashflow.pdf

The Cash Flow Sensitivity of Cash

The average cash-to-assets ratio for U.S. industrial firms more than doubles from 1980 to 2006. A measure of the economic importance of this increase in cash holdings is that at the end of the sample period, the average firm can pay back all of its debt obligations with its cash holdings; in other words, the average firm has no leverage if leverage is measured as net debt. This change in cash ratios and net debt is the result of a secular trend rather than the outcome of the recent buildup in cash holdings of some large firms, and it is much more pronounced for firms that do not pay dividends and for firms in industries whose cash flows became riskier. The average cash ratio increases over the sample period because firms change: their cash flows become riskier, they hold fewer inventories and accounts receivable, and they are increasingly RD in contrast, in our empirical tests, agency considerations are not successful in explaining the increase.

/pdf/why-do-u-s-firms-hold-so-much-more-cash-than-they-used-to-5qi93xtapw.pdf

Why Do U.S. Firms Hold so Much More Cash than They Used to

https://www.nber.org/system/files/working_papers/w6234/w6234.pdf

The determinants and implications of corporate cash holdings

We examine the determinants and implications of holdings of cash and marketable" securities by publicly traded U.S. firms in the 1971-1994 period. Firms with strong growth" opportunities and riskier cash flows hold relatively high ratios of cash to total assets. Firms" that have the greatest access to the capital markets (e.g. large firms and those with credit" ratings) tend to hold lower ratios of cash to total assets. These results are consistent with the" view that firms hold liquid assets to ensure that they will be able to keep investing when cash" flow is too low relative to planned investment and when outside funds are expensive. The" short run impact of excess cash on capital expenditures, acquisition spending and payouts to" shareholders is small. The main reason that firms experience large changes in excess cash is" the occurrence of operating losses. There is no evidence that risk management and cash" holdings are substitutes.

The Determinants and Implications of Corporate Cash Holdings

Agency theories predict that the value of corporate cash holdings is less in countries with poor investor protection because of the greater ability of controlling shareholders to extract private benefits from cash holdings in such countries. Using various specifications of the valuation regressions of Fama and French (1998), we find that the relation between cash holdings and firm value is much weaker in countries with poor investor protection than in other countries. In further support of the importance of agency theories, the relation between dividends and firm value is weaker in countries with stronger investor protection. ACCORDING TO AGENCY THEORIES, THOSE who control firms do so to further their own interests. When corporate governance works well, those in control of a corporation, whom we refer to as controlling shareholders, find it more beneficial to increase shareholder wealth than to expropriate minority shareholders. In contrast, with poor corporate governance, controlling shareholders can derive substantial private benefits from control at the expense of minority shareholders (see, for instance, Dyck and Zingales (2004) and Nenova (2003)). As Myers and Rajan (1998) argue, liquid assets can be turned into private benefits at lower cost than other assets. Liquid assets therefore represent a promising opportunity to investigate the implications of agency theories. According to these theories, we would expect controlling shareholders to overinvest in liquid assets. Existing empirical evidence by Dittmar, Mahrt-Smith, and Servaes (2003) and Kalcheva and Lins (2004) is consistent with this prediction. ∗ Lee Pinkowitz and Rohan Williamson are associated with Georgetown University and Ren´ e

Does the Contribution of Corporate Cash Holdings and Dividends to Firm Value Depend on Governance? A Cross‐country Analysis

This paper shows that there is a close relation between corporate governance and the portfolios held by investors. Most firms in countries with poor investor protection are controlled by large shareholders, so that only a fraction of the shares issued by firms in these countries can be freely traded and held by portfolio investors. We show that the prevalence of closely-held firms in most countries helps explain why these countries exhibit a home bias in share holdings and why U.S. investors underweight foreign countries in their portfolios. We construct an estimate of the world portfolio of shares available to investors who are not controlling shareholders (the world float portfolio). The world float portfolio differs sharply from the world market portfolio. In regressions explaining the portfolio weights of U.S. investors, the world float portfolio has a positive significant coefficient but the world market portfolio has no additional explanatory power. This result holds when we control for country characteristics. An analysis of foreign investor holdings at the firm level for Sweden confirms the importance of the float portfolio as a determinant of these holdings.

/pdf/corporate-governance-and-the-home-bias-9be44vjcl4.pdf

Corporate Governance and the Home Bias

Using a sample of firm years from the United States, Germany and Japan, we examine the effect of bank power on the cash holdings of industrial firms. We show that firms in Japan have higher cash holdings than those in the US or Germany. We also show that the high cash levels are correlated with power of the banks. During periods of high bank power, firms' cash holdings are consistent with banks extracting rents. We conclude that the Japanese banks persuade firms to hold higher cash balances than firms in the US and Germany. This is contrary to widely held beliefs about the Japanese governance system.

https://papers.ssrn.com/sol3/Delivery.cfm/99011712.pdf?abstractid=146431

Lee Pinkowitz

Papers

The determinants and implications of corporate cash holdings

The Determinants and Implications of Corporate Cash Holdings

Does the Contribution of Corporate Cash Holdings and Dividends to Firm Value Depend on Governance? A Cross‐country Analysis

Corporate Governance and the Home Bias

Bank Power and Cash Holdings: Evidence from Japan