Essays in Empirical Corporate Finance

Le, Nhan

Graduate Thesis Or Dissertation

Essays in Empirical Corporate Finance Public Deposited

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Citeable URL: https://scholar.colorado.edu/concern/graduate_thesis_or_dissertations/02870w009

Abstract

The dissertation consists of two essays in the literature of corporate cash holding policy. The first essay investigates the role of large cash holdings on firm recovery following an abrupt negative performance shock. The results show that large cash holdings have a negative effect on performance recovery. This adverse impact of cash on performance does not occur for the same sample firms in a pseudo performance shock event, nor does it occur for matched placebo sample firms that did not experience a similar performance shock. The results suggest that cash holdings have a dynamic effect on corporate behavior and performance, and the agency costs associated with large cash reserves are state contingent. Further investigation reveals that the difference in performance outcome is mainly due to low cash firms significantly downsizing their asset base whereas high cash firms do not follow this pattern. The evidence implies that large cash holdings reduce pressure on management when they need to be highly disciplined to restructure their activities. In the second essay, I examine how managers adjust their corporate cash holding policy in response to the intra-industry bankruptcy filings. I find that on average firms significantly increase their cash holdings following the incidence of bankruptcy filings by their industry peers. This result is in general consistent with managers hedging against potential contagion from these bankruptcies. However, for a subsample of firms in industries with a high degree of concentration I do not find an effect on cash holdings from intra-industry bankruptcies. This result is consistent with firms in concentrated industries expecting to capture enough benefits from their competitors' financial distress that it outweighs any needs to hedge against contagion. Consistent with a precautionary (aka "hedging") motive for the increase in cash holdings, the effect is larger for firms with high leverage or greater growth opportunities. These are firms that potentially will suffer the most from negative spillover effects in terms of increased risk of financial distress or underinvestment. Some tentative evidence suggest that the sources of the cash increase are equity issues and a reduction of net working capital. Overall, the evidence suggest that not only creditors reassess their perceived default risk of surviving firms as empirically documented in prior literature, but so do also the managers of these firms. Although the cash increase is consistent with precautionary behavior on part of the managers, it is not self-evident that this is optimal behavior from a firm value perspective. Although examining a different empirical setting, the evidence in Chapter 1 of this dissertation in fact suggest that the managers' response, no matter how well-intended, may very well be suboptimal due to agency costs of cash.

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