The association between firm-level corporate governance and corporate cash holdings: evidence from some emerging markets

Abstract

A wealth of studies indicates that good corporate governance has a positive impact on company performance. However, it is not always understood how this positive relationship is achieved. In firms where shareholders and management are misaligned and agency costs are high, cash and cash equivalents can be used in ways that lead to poor company performance and to the destruction of shareholder value. In addition to this problem, very few studies on corporate governance focus on emerging markets: “most studies of corporate governance focus on one or a few wealthy economies” (La Porta, Lopez-De-Silanes, Shleifer & Vishny, 1998, p.1117). Therefore, the focus of this study was to address these two main issues. The author of this report set out to understand the impact of corporate governance on corporate cash holdings by focusing on emerging markets. This was first done by reviewing the extensive literature on agency theory, firm-level corporate governance, cash holdings and the three hypotheses for reasons why firms hold cash. Firm-level corporate governance, corporate cash holdings and total assets data was collected for 620 firms in 17 emerging market economies using Thomson Reuters DataStream for the period 2009 to 2012. The data was then used to determine whether firm-level corporate governance, board characteristics, shareholder rights and vision and strategy are associated with corporate cash holdings. The study found that for the selected sample, firm-level corporate governance is negatively correlated to corporate cash holdings in emerging markets. This implies that the flexibility hypothesis is the dominant reason why firms hold cash in emerging markets. Emerging market firms tend to hoard cash because it provides the flexibility for these firms to take advantage of profitable opportunities as they present themselves. This outcome is contrary to the results obtained in prior studies done on firms in developed economies: these firms tend to spend cash quickly on acquisitions and capital projects (spending hypothesis) or they keep cash to avoid under-investing in case they cannot access external credit lines.(shareholder power hypothesis).