Corporate Financial Policy and the Value of Cash

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Corporate Financial Policy and the Value of Cash Faulkender and Wang, 2006, Journal of

Corporate Financial Policy and the Value of Cash Faulkender and Wang, 2006, Journal of Finance, 61 (4): 1957 -1990.

Basic Questions n What is the marginal value of corporate cash holdings? ¨ Previous

Basic Questions n What is the marginal value of corporate cash holdings? ¨ Previous literature: estimate the marginal value of debt, see ¨ Benefit/Costs of cash holdings ¨ How is the value of cash differ across firms ¨ How is the value of cash differ in various corporate polices

Basic Ideas (Three cash regimes) n The marginal value of cash should vary largely

Basic Ideas (Three cash regimes) n The marginal value of cash should vary largely depending on how the cash is used: R 1: increasing distributions to equity via dividend payments or share repurchases, 1 - d ¨ R 2: decreasing the amount of cash that needs to be raised in the capital markets, depending upon the firm’s capital market accessibility, 1/(1 -f ) ¨ R 3: servicing debt or other liabilities of the firm. ¨

Basic Conclusions n The average marginal value of cash across all firms is $0.

Basic Conclusions n The average marginal value of cash across all firms is $0. 94. n As firms’ cash levels and leverage increase, their marginal value of cash decreases significantly. n The marginal value of cash is $0. 13 higher if firm distribute cash stock repurchase rather than by dividend payments. n The average marginal value of cash for FC firms is significantly higher than NFC firms. n The difference in the marginal value of cash between FC firms and NFC firms is large among firms that have valuable investment opportunities but low levels of internal funds. (High Q, Low Inter-funds)

Empirical Predictions

Empirical Predictions

Empirical Methodology n n Excess return = rit - Rit. B is the 5

Empirical Methodology n n Excess return = rit - Rit. B is the 5 x 5 portfolio return (value-weighted), formed in each year.

Empirical Methodology

Empirical Methodology

Data n n n 1971 -2001 Compustat Exclude financial firms and utility firms Trim

Data n n n 1971 -2001 Compustat Exclude financial firms and utility firms Trim firm-specific factors and dependent variables at 1% tails Drop firm-years with NA<0, MV<0, Div<0 Final sample: 82187 firm-years

Summary Statistics

Summary Statistics

Financial Constraints n Payout ratio: total dividends/earnings ¨ n Firm Size: sales ¨ n

Financial Constraints n Payout ratio: total dividends/earnings ¨ n Firm Size: sales ¨ n Sort each year, cut at 30 th(70 th) percentile Long-term bond rating: ¨ n Sort each year, cut at 30 th(70 th) percentile with/without bond rating Commercial paper rating: ¨ with/without commercial paper rating

Group I : Low coverage, Low M/B n Group II : Low coverage, High

Group I : Low coverage, Low M/B n Group II : Low coverage, High M/B n Group III : High coverage, Low M/B n n Which one is the best/worse?

Extensions n Corporate Governance ¨ Dittmar, A. , J. Mahrt-Smith, 2007, Corporate Governance and

Extensions n Corporate Governance ¨ Dittmar, A. , J. Mahrt-Smith, 2007, Corporate Governance and the Value of Cash Holdings, Journal of Financial Economics, 83 (3): 599 -634. ¨ Harford, J. , S. Mansi, W. Maxwell, 2008, Corporate governance and firm cash holdings in the US, Journal of Financial Economics, 87 (3): 535 -555. n Cross listing ¨ n Frésard, L. , C. Salva, 2010, The Value of Excess Cash and Corporate Governance: Evidence from U. S. Cross-listings, Journal of Financial Economics, 98 (2): 359 -384. R&D ¨ Brown, J. R. , B. C. Petersen, 2011, Cash Holdings and R&D Smoothing, Journal of Corporate Finance, 17 (3): 694 -709.

Extensions (cont. ) n Financial Constraints ¨ n Earnings quality ¨ n Sun, Q.

Extensions (cont. ) n Financial Constraints ¨ n Earnings quality ¨ n Sun, Q. , K. Yung, H. Rahman, 2011, Earnings quality and corporate cash holdings, Accounting & Finance, forthcoming. Political Connections ¨ n Denis, D. , V. Sibilkov, 2010, Financial Constraints, Investment, and the Value of Cash Holdings, Review of Financial Studies, 23 (1): 247 -269. Hill, M. D. , K. Fuller, G. W. Kelly, J. Washam, 2010, Corporate Cash Holdings and Political Connections, SSRN working paper, http: //ssrn. com/paper=1601502. Stock Repurchases ¨ Haw, I. -M. , S. S. Ho, B. Hu, X. Zhang, 2011, The Contribution of Stock Repurchases to the Value of Firm and Cash Holdings Around the World, Journal of Corporate Finance, 17 (1): 152 -166.