University of Twente Student Theses


The shareholder value of excess cash

Oude Alink, P.H. (2013) The shareholder value of excess cash.

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Abstract:Is it reasonable to assume that all corporate cash holdings are exactly worth their intrinsic value – despite company-, industry-, and country-specific differences between firms? In recent times, this fundamental question has led to discussions between shareholders and management in various corporations. We show that shareholders are right to question the benefit of large corporate cash holdings, since our models indicate that the shareholder value of cash generally deviates among firms and over time. Also, the marginal value of excess cash is lower in firms with a high amount of excess cash and higher in firms with strongly negative amounts of excess cash. By modeling the relationship between the market value of equity and the value of cash for publicly listed firms, we come up with an estimate of the marginal value of cash. Four our large data set, containing 49,781 firm year observations over 7,123 publicly listed European firms, we find that the marginal value of cash ranges between 0.76 and 1.14, depending on the model employed. Adding the dimension of excess cash to the problem, we find that deducting industry mean or median cash positions from a firm’s cash holding level are appropriate measures for identifying excess cash in corporations; our cash measure being the company’s cash position relative to its total assets. We find that for firms with large negative excess cash holdings, i.e., firms that are far below their industry mean or median, the marginal value of cash is much higher than for firms with moderate levels of excess cash and to an even further extent when compared with high excess cash firms. This evidence points toward the presumption that firms do indeed have an optimum for the amount of cash they hold. Our findings are robust between different specifications of our model, as well as for both our excess cash measures. Furthermore, our results regarding the marginal value of excess cash are in line with literature. There is no previous literature that uses a similar approach to specifically address the value of excess cash, but nevertheless our outcomes regarding the value of excess cash are supported by studies that have taken different approaches to this issue. Overall, we conclude that either too much or not enough cash in firms creates sub-optimal settings. As we have seen from literature, firms with lots of cash for instance tend to engage in acquisitions and other investments that do not add sufficient value to the firm, while firms with a cash shortage miss out on otherwise valuable opportunities. Having found evidence for this sub-optimality of either very large or very low cash holdings by means of our data analysis on the marginal value of excess cash, we recommend financial advisors as well as investors to assess the extent to which a company holds excess cash and to take this into account when valuing the firm.
Item Type:Essay (Master)
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Industrial Engineering and Management MSc (60029)
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