In this paper we evaluate the empirical importance of the contemporaneous presence of financial and labor market imperfections by studying cross-country differences in market valuations of listed companies and firms’ cash holdings. There are several reasons why the study of firm cash holdings is worth exploring. First, in a world of perfect financial markets and no contracting costs, firms do not demand (hold) cash because they can invest in all positive net present value (NPV) projects available to them and pay out the funds that they cannot invest in such projects to shareholders. However, in the presence of imperfect financial markets firms demand cash for different reasons. For example, when agency problems exist. Second, as documented by Bates et al. (2008), the average cash-asset ratio held by companies in the US doubled from 10.48 to 24.03% between 1980 and 2004. This finding appears paradoxical because improvements in financial technology should reduce cash holdings. Third, there is cross-country variability in the cash-assets ratio and the observed cross-country variability may reflect significant differences in institutional environments, in the degree of market imperfections and in the quality of domestic institutions, such as bankruptcy laws, the state of development of capital markets, and patterns of corporate governance. Finally, the analysis of the role played by market imperfections and institutions in determining cash holdings provides a valuable background to the design of welfare improving economic policies. Our results show that financial market imperfections are positively correlated with firms’ cash holdings and that the latter are larger wherever employment protection laws (EPL) are stricter. Moreover, stock markets value liquid companies less in economies with higher EPL levels. This paper was also a product of the research project on the effects of the presence of market imperfections on firms' decisions carried out together with other Italian university.

Cash Holdings, Firm Value and the Role ofMarket Imperfections. A Cross CountryAnalysis

CALCAGNINI, GIORGIO;GIOMBINI, GERMANA
2010

Abstract

In this paper we evaluate the empirical importance of the contemporaneous presence of financial and labor market imperfections by studying cross-country differences in market valuations of listed companies and firms’ cash holdings. There are several reasons why the study of firm cash holdings is worth exploring. First, in a world of perfect financial markets and no contracting costs, firms do not demand (hold) cash because they can invest in all positive net present value (NPV) projects available to them and pay out the funds that they cannot invest in such projects to shareholders. However, in the presence of imperfect financial markets firms demand cash for different reasons. For example, when agency problems exist. Second, as documented by Bates et al. (2008), the average cash-asset ratio held by companies in the US doubled from 10.48 to 24.03% between 1980 and 2004. This finding appears paradoxical because improvements in financial technology should reduce cash holdings. Third, there is cross-country variability in the cash-assets ratio and the observed cross-country variability may reflect significant differences in institutional environments, in the degree of market imperfections and in the quality of domestic institutions, such as bankruptcy laws, the state of development of capital markets, and patterns of corporate governance. Finally, the analysis of the role played by market imperfections and institutions in determining cash holdings provides a valuable background to the design of welfare improving economic policies. Our results show that financial market imperfections are positively correlated with firms’ cash holdings and that the latter are larger wherever employment protection laws (EPL) are stricter. Moreover, stock markets value liquid companies less in economies with higher EPL levels. This paper was also a product of the research project on the effects of the presence of market imperfections on firms' decisions carried out together with other Italian university.
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/11576/2300027
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