The cash-holding policy of a firm is one of the most important corporate financial decisions that a manager has to make; when there is an inflow of cash, the manager must decide whether to disburse the cash to shareholders as dividends, use it for external investment opportunities, spend it internally, or hoard it for the future needs of the firm. Therefore, managers often struggle to maintain an optimal level of cash holdings to trade off between the costs and benefits associated with varying degrees of liquidity. The conflicts of interest between managers and shareholders arising mainly from the separation of ownership and control have been well-documented. One of these conflicts is related to the firm’s cash holdings. Jensen (1986) argues that agency conflicts existing between shareholders and managers can be most severe when firms have large free cash flows. Managers can have incentives to hold large amounts of cash reserves to pursue their own objectives at the expense of those of shareholders (Jensen & Meckling, 1976).
Consequently, agency problems are an important determinant of corporate cash holdings. Several studies shows that firms with poor corporate governance often hold more cash and the value of cash holdings is lower with international data (Dittmar et al., 2003; Pinkowitz et al., 2006). Conversely, Harford et al. (2008) find that firms with weaker corporate governance structures actually have smaller cash reserves. Prior work is mainly for US with low shareholder protection or cross-country samples, but very little evidence on this relationship in Taiwan. Since Taiwanese listed firms are characterized by the presence of concentrated ownership, low institutional ownership and collateralized shares of the board of directors, relative to US firms, this study will shed additional light on the role of firm-level corporate governance in the determination of corporate cash holdings through the use of the Taiwan data.
This study examines the relationships between corporate governance, cash holding policies, payment decisions of excess cash holdings and the overall effects of excess cash holdings on the future value of publicly-listed firms in Taiwan. The sample provides 8,342 firm-year observations on a total 1,248 TSE-listed firms, covering the period from 1996 to 2007. Our analysis reveals that ownership plays an important role in determining corporate cash holdings in Taiwan. Moreover, we provide evidence that the relationship between ownership and cash holdings is non-monotonic. The results also suggest that a higher collateralized ratio will have larger firm’s cash holdings, whereas firms with an independent board tend to have smaller cash reserves. Overall, the evidence in this paper indicates that internal governance mechanisms such as board characteristics and ownership concentration are important determinants of corporate cash holdings for firms listed in Taiwan. The results support the earlier finding by Dittmar et al. (2003) that firms with weaker corporate governance structures are likely to have greater cash reserves. Further, our results demonstrate that firms with greater cash holdings are likely to return their bond debt. The capital expenditure, R&D expenditure and dividends are generally not associated with a firm’s cash position. Finally, we also provide evidence that firms with greater change in cash reserves will decline their growth prospects.