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Cash Holding and Corporate Performance
University van Amsterdam Amsterdam Business School BSc Economics & Business Specialization Finance &Organization
Author: Tianyang Lan Student number: 10846492 Thesis supervisor: Dr. J.E.(Jeroen) Ligterink Finish date: 01-2018
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Statement of Originality This document is written by Student Tianyang Lan, who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
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ABSTRACT There are articles stating that holding cash has certain advantages to the company, while there
are evidence showing that cash may be harmful. The aim of this thesis is to find the relationship
between the cash holding of the company and the company performance in Europe. It provides
the regression analysis based on the data of European companies. The result shows that there is a
negative relationship between the cash and the performance in Europe, but the relationship
becomes positive during the time of financial crisis. It suggests that holding too much cash is bad
for the company, but during the recession time, the excess cash may be good for the company
performance.
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Chapter 1: Introduction
The rising cash holdings of U.S. firms are increasingly in the hands of a few U.S.
companies, for which Apple, Microsoft, Alphabet, Cisco Systems and Oracle are
sitting on $504 billion, that is 30% of the 1.7 trillion in cash and cash equivalents
held by U.S. non-financial companies in 2015 (Krantz, 2016). The question is why
would these companies own such a large number of cash on hand. Krantz also
mentions that Apple shows the strong disconnect between big cash balances and
stock return, and the investors have lost $240 billion in paper profits since the
stock peaked (2016). It can be argued that excess cash holding of a company may
harm the interest of investors. On the other hand, Seth Klarman, as on the the best
value investors in history, always keeps a significant portion of his portfolio in
cash, and since he founded Baupost Group in 1982, it has achieved high teens
returns for investors every year (Hargreaves, 2017). Therefore, it can also be
supported that holding cash may be possible to benefit the investors. Since the
excess cash can bring both benefits and costs to the shareholders, it is worth to
investigate whether the firms are willing to hold more cash or not. If cash may
affect the performance of firms. The central research question of this paper is to
discuss the relationships between the company performance and the cash holding
level in Europe area, and would the factor of recession influences this relationship.
Although some of the articles already did the similar test, most of them are
focusing on the U.S. or global market. There are very few articles discussing the
relations between cash and performance of European firms. This paper contributes
to the existing literatures by reporting the test result of Europe, since the analysis
will be based on the data of European market.
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The remainder of this paper will be construct as follow: Chapter 2 will be
the literature review, showing the discussion of existing studies. The methodology
will be introduced in Chapter 3. Chapter 4 will show the data and summery
statistics. In Chapter 5, the analysis results will be discussed. Finally, there will be
a conclusion and further discussions in Chapter 6.
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Chapter 2: Literature review
2.1. Benefits of Cash
Based on the existing literature, it can be argued that holding cash has both
benefits and drawbacks. According to Haushalter, holding cash has certain benefits
since it may enhance the flexibility and in strategic response and provides
deterrence (2007). When external financing costs too much, cash allows firms to
invest in opportunities and reduces the risk of underinvesting in strategic
opportunities (Nason, 2016). Almeida argues that the company with higher cash
holdings generally has higher capacity to undertake profitable investment
opportunities (2004). In addition, Acharya (2005) provides evidence that cash
holding may secure investment through hedging against cash flow deficits. It can
be suggested that the holding excess cash is able to reduce the impact of financing
frictions and fluctuations in the availability of internal funds on investment
(Arslan, 2006). Therefore, holding cash may have positive effects on companies.
2.2. Costs of Cash
On the other hand, holding cash may bring certain drawbacks to the
company. According to Kalcheva and Lins, the cash held by firm may lead to a
managerial agency problem (2007). The agency problem occurs when there are
conflicts of interest between the shareholders and managers over the payout policy,
and the conflicts are severe if the firm generates substantial cash flow, in which the
problem is how to motivate managers to disgorge the cash rather than investing it
at below the cost of capital or wasting it (Jensen, 1986). It is possible to have over-
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investment in less profitable opportunities in a company (Richardson, 2006).
Hence, cash holding may also have a negative influence on the performance.
2.3. The Effects of Financial Crisis
The recession around 2008 can be argued as one of the most serious crises in
the global financial markets. During a crisis, firms face tighter financial constraints
and as a result this is a relevant period to test the importance of this channel of the
benefits of cash holdings.
Song and Lee (2012) concludes that the financial crisis has systematically
changed the cash holing policy of firms. If the economy is bad and deteriorating,
managers increase cash holdings to prepare for the uncertainty in the economy, and
managers should deplete the cash reserve to exercise growth opportunities when
the economy is good and improving in the future (Chen, 2015).
2.4. Test results in US market
Nason and Patel (2016) use the sample of publicly traded manufacturing
U.S. firms between 2004 and 2010 to examine whether the relationship between
cash and stock market performance changes during the economic crisis. Their
result shows the relation between the cash holding and the corporation
performance is positive, and the overall benefits of holding cash shows to be lower
in the pre-recessionary period, which means it is better for firms to hold cash
during the crisis period.
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2.5. Hypothesis
The test of this paper is going to be focus on Europe market. Since both of
US and Europe are developed, it can be expected that it will generate the same
conclusion as with Nason and Patel (2015). Therefore, the hypothesis of this paper
is there is a positive relationship between the cash holding and the company
performance of the selected firms for the sample period, and the relationship would
become stronger during the financial crisis.
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Chapter 3: Model
The regression model of this paper is as follow:
π ππ΄ = π½& + π½(πΆππ β + π½-π΄ππ ππππππ ππππ + π½7π·πππ‘πππ‘ππ + π½;πΆππππ‘πππππ‘πππ ππ‘π¦+ π½?πΉππππ ππ§π + π½Cπ ππππ π πππ β πΆππ β + π
As the dependent variable of this model, ROA can be seen as a measurement of
company performance, it reflects the ability of a company to generate profit by
using the asset. Since ROA is not easy to be manipulated, it can be a more
objective measurement for company performance (Zhang, 2011). As the aim of
this paper is to test the affect of cash holdings on the performance, the explanatory
variable is cash, which is measured as the logarithm of total cash and short-term
investment of a company. According to the researches regarding to the factors that
affect the company performance, it can be argued that the selling volume,
expenditure scales, debt scales, and the firm size may all influence the
performance. In order to better perform the test, the similar control variables which
are in line with these factors as Nason and Patel (2016) had will be used in this
paper. Absorbed slack can be measured by the ratio of selling and general expense
to sales. According to Tan, slack buffers a firmβs technical core from
environmental turbulence, but also may cause agency problems, that may influence
performance (2003). Debt ratio is the ratio of total debt to total asset. Furthermore,
the Capital intensity can be calculated by using the capital expenditure scaled by
sales. Also, the logarithm of total asset is going to be used as the representative of
the Firm size. Afterwards, a regression dummy multiplied by cash is added to the
model, in order to test the relationship between the total cash holding and
performance of the firm.
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Chapter 4: Data and Summary Statistics
The data of this paper are all collected from Compustat database on Wharton
Research Data Services website (WRDS). 40 companies from different countries in
Europe are selected as the samples of this paper from the list of largest European
companies by revenue (2018). The list of all the 40 companies are shown on Table
1, includes the Industry details and country of headquarter.
Table 1
List of Companies
Company Industry Country Air France-KLM Aviation France Airbus Aeronautics and defence France Alstom Conglomerate France Anglo American Mining United Kingdom AstraZeneca Pharmaceuticals United Kingdom BASF Chemicals Germany Bayer Pharmaceuticals Germany Bouygues Conglomerate France BP Oil and gas United Kingdom Carrefour Retail France Centrica Electric utility United Kingdom Continental Auto and truck parts Germany Daimler Automotive Germany Deutsche Post Postal services Germany Deutsche Telekom Telecommunications Germany E.ON Electric utility Germany Enel Electric utility Italy Engie Electric utility France Ericsson Electronics Sweden
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Exor Investment Italy GlaxoSmithKline Pharmaceuticals United Kingdom NestlΓ© Consumer goods Switzerland Nokia Electronics Finland Novartis Pharmaceuticals Switzerland OMV Oil and gas Austria Orange Telecommunications France Repsol Oil and gas Spain Rosneft Oil and gas Russia Royal Dutch Shell Oil and gas Netherlands Schneider Electric Electrical equipment France Siemens Conglomerate Germany Sistema Conglomerate Russia Statoil Oil and gas Norway Telecom Italia Telecommunications Italy TelefΓ³nica Telecommunications Spain Unilever Consumer goods Netherlands Vinci Construction France Vivendi Mass media France Volkswagen Automotive Germany Volvo Heavy equipment Sweden
This table reports the list of 40 sample companies, including the industries and the countries.
The data of all the 40 companies from 2005 to the end of 2017 will be used
to do the regression test. According to the timeline of the major events during the
financial collapse period from the paper of Hausman and Johnston, in February
2007, HSBC announces loan loss provisions signaling the issues with sub-prime
loans, and in February 2009, countries introduce new regulations over banking
industry, increase the control in banks that with troubled assets and infuse more
money into the economies (2014). Therefore, the time from the beginning of 2007
to the second quarter of 2009 is set as the financial crisis period. Figure 1 shows
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the average cash to total asset ratio of all 40 companies across the whole period. It
is shown that the cash holding starts to decrease from 2007 and increases after the
beginning of 2009. Starting from 2009, the total cash to asset ratio are fluctuated
around 0.1. It is worth to be mentioned that the amount of cash relative to asset
rapidly increases during the period of 2007-09 to 2008-03.
Figure 1
This chart indicates the average of total cash and short-term investment to total asset ratio of all the 40 sample companies over the sample period of time.
Table 2 records the means and standard deviations of all the variables, and
the correlations among the variables. All the other correlations are not significantly
large except the correlation between the log of cash holding and the firm size. It
0.08
0.1
0.12
ChartofCashtoAssetRatio
cash/asset
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reports the correlation between these two variables is 0.848, which means the size
of a firm might be positively highly correlated with the cash holding. This high
correlation is reasonable since the firm size is calculated by the logarithm of total
asset, which includes all the cash and short term investment.
Table 2
Means, standard deviations, and correlations
Mean SD ROA cashlogAbsorbedslack
Debtratio
Capitalintensity Size
recession*cash
ROA 0.012 0.015 1 cashlog 3.807 0.508 -0.0957 1 Absorbedslack 0.825 0.112 -0.353 -0.0561 1 Debtratio 0.262 0.121 -0.181 0.0513 -0.271 1 Capitalintensity 0.169 0.161 -0.199 0.125 -0.325 0.289 1 Size 4.896 0.456 -0.0938 0.848 -0.0894 0.100 0.195 1 recession*cash 0.736 1.484 0.110 -0.0777 -0.0543 -0.0376 -0.033 -0.043 1
This table reports the sample mean, standard deviation of all the variables, and the correlation among the variables.
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Chapter 5: Regression Analysis and Discussion
The robust regression test was performed on STATA, and Table 3 reports
the summary of the regression results that does not include the recession dummy.
It indicates that the coefficient of logarithm of cash is -0.0027, and the p-value is
0.024. It can be argued that holding more cash may slightly negatively affect the
performance in European companies, and the relation is meaningful at 2.5%
significant level. To be more precise, one unit of log cash may result in 0.0027
decrease in the ROA of the firm. Moreover, the coefficients of the three control
variables, which are Absorbed slack, Debt ratio and Capital intensity, are negative
and small numbers. All of the three coefficients are significant at the level of 1%. It
means the companies with higher slack, debt and capital intensity, will be possible
to have relative lower ROA. However, the table shows the coefficient for Size is
not significantly different from zero. It indicates that the size of a firm does not
have significant relationship with the corporation performance.
The regression result shows a negative relation between the cash holding and
performance, which is not in line with the hypothesis. It is possible to have
negative relationship since the excess cash may lead to overinvesting in less
profitable opportunities, increases entrenchment and results in poor corporate
governance (Nason, 2015). The reason of the different findings of this paper with
Nason and Patelβs paper can be explained by the difference between the Europe
and the U.S. market. In particular, Nason and Patelβs data are all from the
companies within one country, while in this paper, the 40 companies are randomly
selected from several European countries. The relationship may be affected due to
the different policies or currency conditions. In addition, according to Tson
Soderstrom (2003) the Europe Corporate Governance is still to be improved
compared with it of the United States, and this can be another reason for the
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different conclusion.
Table 3
Regression analysis 1
independentVariables Coefficient t-Statistic P-value
LogCash -0.0027 -2.26 0.024
AbsorbedSlack -0.0701 -21.77 0.000
DebtRatio -0.0295 -11.63 0.000
CapitalIntensity -0.0276 -12.42 0.000
Size 0.00064 0.44 0.660
_cons 0.0897 18.73 0.000
Observation 1998
F(5,1992) 137.69
R-squared 0.2898 This table reports the robust regression test results without the regression dummy.
Table 4 shows the results of the regression that includes the recession
dummy. It indicates the coefficient of the recession dummy multiplied by log cash
is 0.00059 and significant at 1% level. Precisely, one unit rise on log cash may
generate 0.00059 increasing in the ROA of the firm. This result suggests that
holding cash during that financial crisis period is not as bad as doing it when there
is no recession. However, cash holding may possibly help to increase ROA at some
level, which improves the overall performance. The result is in line with one of
Nason and Patelβs conclusions, which is during the recession period, it shows more
benefits for firms to hold cash. It draws the same conclusion as the previous
literature review in Chapter 2.3.
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Table 4
Regression analysis 2
independentVariables Coefficient t-Statistic P-value
LogCash -0.0025 -2.04 0.041
AbsorbedSlack -0.0695 -21.58 0.000
DebtRatio -0.0292 -11.49 0.000
CapitalIntensity -0.0274 -12.34 0.000
Size 0.00046 0.32 0.751
Recession*LogCash 0.00059 3.07 0.002
_cons 0.0885 18.49 0.000
Observation 1998
F(6,1991) 115.15
R-squared 0.2931 This table reports the robust regression test results with the regression dummy multiplied by log cash.
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Chapter 6: Conclusion
Analyzing the influences of cash holdings during the financial crisis is
important for both finance and strategy literature. Under recession, the choice to
hold or spend cash is salient; holding cash buffers a firm from threats, but spending
cash may allow firms to exploit new opportunities. The dilemma caused substantial
debate in public discourse (Nason, 2016).
In summary, the main aim of this thesis is to test the relationship between
the cash holding and the performance of the firm in Europe. It concludes that there
is a negative relation between the cash and the performance, but this relationship
may inverse and become positive during the recession time. It suggests that
holding excess cash may harm the company in Europe, but is possible to benefit
the company during the Financial crisis periods.
The limitation of this thesis is that the sample size is relatively small, it is
better to collect more data and generate more accrue results. Also, the control
variables in the model is limited, the further research should be completed with
finding more control variables that may affect the corporation performance.
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References
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