Cash Holdings, Dividend Policy, and Corporate Governance: A Cross-Country Analysis

The cash and marketable securities held by publicly traded companies pose a challenging corporate governance problem. Especially for smaller, riskier companies and those with abundant investment opportunities, cash holdings can add value by providing a buffer against adverse outcomes as well as a low-cost means of funding growth opportunities. But there is also a clear downside for investors in excess corporate cash: For controlling shareholders intent on expropriating minority shareholders, it's far easier to divert cash to "private" uses than to make a plant disappear. And even in cases not involving direct expropriation, there is also the well-documented tendency of managers in mature companies to retain excess cash instead of paying it out to shareholders-and then waste it on value-reducing projects such as diversifying acquisitions or other low-return expenditures. This article summarizes the findings of a study, published recently in the Journal of Finance, in which the authors addressed the following question: Does the market assign a value of at least a dollar to each additional dollar of cash holdings in companies in weaker governance regimes, or do investors effectively discount the value of that cash when setting stock prices to reflect the greater opportunities for expropriation? Using a sample of companies representing 35 countries over an eleven-year period (1988-1998), the authors found that in countries deemed to have high investor protection, a dollar of liquid assets is worth roughly a dollar to minority investors. But, in countries with less investor protection, a dollar of liquid assets is worth much less, in some cases as little as $0.29. Since cash paid out as dividends is thereby exempted from the possibility of expropriation, the authors also explored the possibility that investors assign a premium value to dividends in countries with less investor protection. And the study provided strong support for this hypothesis: In one model of firm value tested, a $1 increase in a company's dividend per share ratio was associated with an increase in firm value of almost $10 in countries with substandard minority shareholder protection (as compared to only a $4 increase for companies in stronger governance regimes).