Cash Holdings, Corporate Governance Structure and Firm Valuation Kin Wai Lee Assistant Professor Division of Accounting

S3-B2A-19 Nanyang Avenue Nanyang Business School Nanyang Technological University Singapore 639798 Tel : (65) 6790-4663 Fax : (65) 6792-4217 email : akwlee@ntu.edu.sg Cheng-Few Lee Rutgers University Distinguished Professor of Finance Department of Finance School of Business Rutgers University United States of America. Phone: (732) 445-3907 Fax: (732) 445-5927 E-mail: lee@rbs.rutgers.edu.

Abstract Firms with higher board independence, smaller boards, and lower expected managerial entrenchment, have lower cash holdings. We find that the negative association between cash holdings and managerial entrenchment is mitigated by stronger board structures. Specifically, in firms with higher expected managerial entrenchment, those with higher proportion of outside director on the board and smaller board size have lower cash holdings. We also find that firm value is negatively associated with cash levels. The negative association between firm value and cash holdings is more pronounced in firms with (i) lower proportion of outside directors, (ii) larger boards and (iii) higher expected managerial entrenchment. For firms with both high cash holdings and high expected managerial entrenchment, investors additionally discount the valuation of firms with lower proportion of outside directors and those with larger boards.

1. Introduction In South-East Asia (ASEAN), cash represents a substantial portion of corporate assets. ASEAN firms increased their mean cash holding from 8% in 1996 to 12% in 2005. While larger cash holdings increases internal financial flexibility by reducing the costs associated with external financing, there may be potential adverse consequences associated with holding excessive cash. Central to this view is the conflict between managers and shareholders over the deployment of corporate resources when firms have large free cash flow (Jensen, 1986). Self-interested managers may pursue private benefits of control by holding excessive cash and overspending cash on valuedestroying projects. This paper examines the relation among cash holdings, corporate governance structure and firm valuation. Specifically, our primary research questions are: (1) Do firms with stronger governance structure have lower corporate cash holdings? (2) In firms with high cash holdings, is firm valuation higher when corporate governance structure is stronger? (3) In firms with both high cash holdings and high expected managerial entrenchment, do firms with stronger board structure have higher valuation of cash reserves? Prior US research provides mixed evidence on whether investors should be concerned with large cash reserves. Mikkelson and Partch (2003) find that large extreme cash holdings is not associated with poor firm performance and do not represent conflicts of interests between managers and shareholders. However, Harford (1999) shows US firms with large cash reserves spend more on acquisitions and those acquisitions by cash-rich firms are value-destroying. Harford, Mansi and Maxwell (2007) find that in the United States, firms with weaker corporate governance structures (proxied by antitakeover provisions) actually have smaller cash reserves. They document that poorly governed firms dissipate cash more quickly and the firms spend the cash mainly on acquisitions. Furthermore, firms with low shareholder rights and excess cash have lower profitability and valuations. They do not find any association between corporate cash holdings and board attributes such as board size and board independence. Dittmar and Mahrt-Smith (2007) find that investors assign a much lower value to an additional dollar of cash holdings of a poorly governed firm compared to a wellgoverned firm in United States. Furthermore, they document that firms with both high excess cash and poor governance subsequently experience low operating

performance. The negative impact of large cash holdings on future operating performance is cancelled out if the firm is well governed. Using international data, prior research find that in firms in countries with poor shareholder protection, managers can hoard cash and pay low dividends. Dittmar, Mahrt-Smith, and Servaes (2003) find that firms in countries with strong shareholder protection hold less cash. Pinkowitz, Stulz, and Williamson (2006) show that cash is worth less to the minority shareholders of firms in countries with low investor protection. This finding is consistent with the hypothesis that poor protection of investor rights makes it easier for management and controlling shareholders to expropriate corporate resources for their own benefit. Using data from 31 countries, Kalcheva and Lins (2007) find that (i) firms with entrenched managers hold more cash, particularly when country-level shareholder protection is poor, and (ii) firm values are discounted when firms with entrenched managers hold high levels of cash, particularly when country-level shareholder protection is poor. Our sample consists of 1,061 firms for 4,206 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand). We begin our analysis by examining the association between cash holdings, board structure and management ownership structure. After controlling for economic determinants of cash holdings, we find that firms with higher proportion of outside directors on the board, separate CEO and chairman positions, and smaller boards, have lower cash holdings. Thus, firms with stronger board structure hold lower cash reserves beyond their operations and investment needs. At low level of managerial equity ownership, there is no association between corporate cash holding and managerial equity ownership. In contrast, as managerial ownership continues to increase to a high level, firms hold more cash reserves. Our result is consistent with Morck, Shleifer and Vishnys (1988) argument that at high managerial ownership, the entrenchment effect dominates and consequently, firms with high expected managerial entrenchment hoard more cash. We also find that the negative association between cash holdings and expected managerial entrenchment is mitigated by stronger board structures. Specifically, in firms with higher expected managerial entrenchment, those with higher proportion of outside director on the board, and firms with smaller board size, have lower cash holdings. 4

Next, we examine the association between firm value and cash holdings. We find that firm value is negatively associated with cash levels. This result suggests that in firms with high cash holdings, investors are concerned that managers have more discretion to deploy corporate resources on value-destroying projects, consistent with Jensens (1986) theory on the agency costs of free cash flow. This raises an important question: Do alternative corporate governance structures systematically affect the association between firm valuation and corporate cash reserves? Our results indicate that the negative association between firm value and cash holdings is more pronounced in firms with (i) lower proportion of outside directors, (ii) larger boards and (iii) higher expected managerial entrenchment. Thus, our findings suggest that in firms hold excess cash, firm valuation is discounted by investors when corporate governance mechanisms impose weak constraints to curb managerial utilization of excess cash. We also document that for firms with both high cash holdings and high expected managerial entrenchment, investors additionally discount the valuation of firms with lower proportion of outside directors on the board and those with larger boards. Collectively, our results are consistent with the hypothesis that when entrenched managers pursue their interests at the expense of external shareholders, liquid assets are worth less to external shareholders in firms in which the appropriation of private benefits is easier because some of these assets are used to finance the entrenched managers private benefits. As a robustness test, we extend our measure of cash to consider the effects of governance on the valuation of excess cash. Following Dittmar and Smith (2007), we define excess cash as cash held by firms that is not needed for firm operations or investments. Our results are qualitatively similar. Firms with strong board structures and low expected managerial entrenchment have low excess cash. In addition, excess cash is valued higher in well-governed firms compared to poorly-governed firms. The combination of excess cash and high expected managerial entrenchment exacerbates agency costs, resulting in lower firm valuation, especially in firms with weaker board structure. Finally, we examine the effect of excess cash on subsequent operating performance, measured by return on assets (ROA). We find that for firms that use excess cash 5

holdings over the year, a larger beginning balance of excess cash results in lower future operating performance. The negative association between future return on assets and excess cash is mitigated in firms with high proportion of outside directors on the board. Furthermore, the negative association between future return on assets and excess cash is more pronounced in firms with larger boards. In addition, firms with high expected managerial entrenchment and excess cash have lower subsequent profitability. We also provide some evidence that when firms have both high excess cash and high expected managerial entrenchment, (i) those with higher proportion of outside directors on the board, and (ii) those with smaller boards, have better subsequent operating performance. Collectively, our results indicate that the negative association between subsequent operating performance and excess cash in firms with expected managerial entrenchment is mitigated in firms with stronger board structure. We contribute to the literature on cash holdings and corporate governance as follows. First, Kalcheva and Lins (2007) find that investors discount the valuation of firms with both high expected managerial entrenchment and high cash reserves. Thus, their paper raises the question of what specific corporate governance mechanisms may mitigate the negative association between firm valuation and cash reserves in firms with high expected managerial entrenchment. Our paper directly examines this question by providing evidence that strong board structure mitigates the valuation discount of cash reserves in firms with high expected managerial entrenchment. Second, Dittmar and Marht-Smith (2007) investigate how corporate governance impacts firm value by comparing the value and use of cash holdings in US firms. Their measures of corporate governance include the degree of managerial entrenchment due to takeover defenses and the presence of large shareholder monitoring. However, takeovers are infrequent in Asia and hence, managers of Asian listed firms face little disciplinary pressure from the market for corporate control. Furthermore, most firms in Asia are controlled by a single and large ultimate shareholder (Claessens, Djankov and Lang 2000) and this may curb the monitoring effectiveness of external large shareholder. We complement the findings of Dittmar and Marht-Smith (2007) by examining the effectiveness of other corporate governance mechanism such as board structure in constraining managerial opportunism over cash reserves in a setting where entrenched managers are likely to face limited disciplinary pressure from the takeover market and external large 6

shareholders. Thirdly, our paper also extends prior studies that examine country-level investor protection and cash reserves (Dittmar, Mahrt-Smith, and Servaes (2003) and. Pinkowitz, Stulz, and Williamson (2006)) by examining the effect of firm-level corporate governance structure on cash holdings. The remainder of the paper is organized as follows. Section 2 reviews prior studies and develops the hypotheses. Section 3 describes the data and method. Section 4 presents the results of our empirical tests and provides alternative specifications. Section 5 contains the conclusions.

2. Theory and Hypothesis

2.1 Prior research An important strand of prior literature focuses on the determinants of corporate cash holdings. Kim et al. (1998) report that US firms with high costs of external financing, more volatile earnings, and low profitability hold high cash. Using a sample of US listed firms, Opler et al. (1999) provide evidence that small firms and firms with strong growth opportunities and riskier cash flows hold larger amounts of cash. Pinkowitz and Williamson (2001) document that the monopoly power of banks has a significant impact on cash balance. Another stream of research examines the association between corporate governance structure and cash holdings. The central theme of these studies is that in firms with high cash reserves, entrenched managers have the incentives to spend corporate resources in negative net present value projects that harm shareholders, consistent with the Jensens (1986) agency costs of free cash flow. Prior US research provides mixed evidence on whether investors should be concerned with large cash reserves. Mikkelson and Partch (2003) find that large extreme cash holdings is not associated with poor firm performance and do not represent conflicts of interests between managers and shareholders. However, Harford (1999) shows US firms with large cash reserves spend more on acquisitions and those acquisitions by cash-rich firms are value-destroying. Harford, Mansi and Maxwell (2007) find that in the United States, firms with weaker corporate governance structures actually have smaller cash reserves. They interpret their result as suggesting that in USA, entrenched managers 7

avoid visible accumulations of excess cash because large cash stockpiles attract the attention of shareholders and can be used to self-finance a corporate control action against the managers. The combination of excess cash and weak shareholder rights leads to increases in capital expenditures and acquisitions 1 and result in lower profitability and valuations. In the US, weakly controlled managers dissipate cash quickly on acquisitions and capital expenditures. Research outside United States provide evidence that in firms in countries with poor shareholder protection, managers can hoard cash and pay low dividends. Dittmar, Mahrt-Smith, and Servaes (2003) find that corporate cash holding is negatively associated with country-level shareholder protection. Pinkowitz, Stulz, and Williamson (2006) find that cash is worth less to the minority shareholders of firms in countries with low investor protection. Furthermore, they find that minority shareholders value dividends more in countries with weak shareholder protection. These findings are consistent with the hypothesis that poor protection of investor rights makes it easier for management and controlling shareholders to expropriate corporate resources for their own benefit. Using data from 31 countries, Kalcheva and Lins (2007) find that cash holding is higher in firms with higher expected managerial entrenchment (proxied by the managerial voting rights) and this association is magnified when country-level shareholder protection is poor. In addition, they document that firm values are discounted when firms with entrenched managers hold high levels of cash, particularly when country-level shareholder protection is poor. They also find that negative association between firm valuation and managerial entrenchment is mitigated in firms that pay dividends and this relationship is magnified when country-level shareholder protection is poor.

2.2 Hypothesis Our central theme is that firms with strong corporate governance structure have low cash holdings. Stronger corporate governance structure is associated with more effective monitoring of managers and hence, limits managerial flexibility to spend corporate resources on negative net present value projects. If cash facilitates overinvestment and rent-seeking by entrenched managers, we hypothesize that firms
1

They also document that US firms with weaker governance structures choose to repurchase instead of increasing dividends, avoiding future payout commitments.

with entrenched managers will hold more cash. A firms board of directors is responsible for monitoring and evaluating senior management. The key determinant of the boards effectiveness is the board structure such as board size and board independence. Yermack (1996) finds that smaller boards are more efficient as they provide greater decision making. Outside directors perform a corporate governance role by mitigating managerial entrenchment and expropriation of firm resources. The governance literature generally suggests that as boards become increasingly independent of managers, their monitoring effectiveness increases, thereby decreasing managerial opportunism and enhancing firm performance. Thus, we expect firms with strong board structure have low cash holdings. Prior studies suggest that strong boards are associated with separation of CEO and chairman positions, high proportion of outside directors and small board size. If strong boards reduce management propensity to hoard excessive cash, we predict that firms with higher proportion of outside directors on the board, those with smaller board size, and those that separate CEO and chairman of the board positions, have low cash holdings. We also examine the effect of ownership structure of firms in determining their cash holdings. Managers may have incentives to hold large cash balances, which enable them to pursue their own objectives at the expense of those of shareholders by consuming perquisites or making inefficient investment decisions (Jensen, 1986). If greater ownership by managers can align the interests of managers and shareholders, we expect a negative relationship between managerial ownership and cash holdings (i.e. the incentive alignment effect). However, the impact of managerial ownership is likely to be non-monotonic. As managerial ownership continues to increase, there is greater degree of managerial control and entrenchment of managers (Morck et al., 1988; McConnell and Servaes, 1990). Consequently, managers may choose to hold more cash to pursue private benefits and hence the relationship between cash holdings and managerial ownership can become positive at higher levels of managerial ownership (i.e. the entrenchment effect) 2 . Thus, we predict that at low level of
Using UK firms, Okzan and Okzan (2004) find that cash holdings fall as managerial ownership increases up to 24%, rise as managerial ownership increases up to 64%, and fall again when managerial ownership exceeds 64%. However, they did not find any association between cash holdings and board structure such as board independence and board size. They do not investigate the impact of corporate governance structure (such as managerial ownership and board structure) on the valuation of excess cash.
2

managerial ownership, corporate cash holding is negatively associated with managerial ownership (alignment of interest effect) but at high level of managerial ownership, corporate cash reserves are positively associated with managerial ownership (entrenchment effect). Following prior studies (Morck et al., 1988; McConnell and Servaes, 1990), we posit that high managerial equity ownership is associated with high expected managerial entrenchment. Hence, a natural question is whether strong board structure mitigates the negative association cash holding and expected managerial entrenchment. If board of directors plays an effective governance role in constraining managerial private rent-seeking activities, we predict that the negative association between excess cash holdings and expected managerial entrenchment is mitigated in firms with stronger board structure. In terms of firm valuation, if excess cash is associated with higher agency costs, we hypothesize that (i) firm valuation is negatively associated with excess cash holdings, and (ii) the negative association between firm valuation and excess cash holdings is mitigated in firms with stronger board structure and lower expected managerial entrenchment, and (iii) in firms with both high cash holdings and high expected managerial entrenchment, those with stronger board structure have higher firm valuation.

3. Data and Method 3.1 Sample formation We begin with the Worldscope database to identify listed firms in five Asian countries comprising Malaysia, Philippines, Indonesia, Singapore and Thailand during the period 2001 to 2005 3 . We exclude financial institutions because of their unique financial structure and regulatory requirements. We eliminate observations with extreme values of control variables such as sales growth and leverage (discussed in section 3.2 below). We obtain annual reports for fiscal year 2001 and 2005 from the Global Report database and company websites. Our final sample consists of 1,061
In this study, we focus on the South-East Asian countries in Asia because of the high costs of manual data collection of board and ownership variables from annual reports. Thus, our sample excludes South Korea, Taiwan and Hong Kong.
3

10

firms for 4,206 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand). We manually collect data on the board characteristics such as CEO-chairman duality, board size and the number of outside directors from the annual report. An outside director is defined as a director who is not a current nor former employee of the firm. We also examine the annual report to manually collect data on the number of common shares held by the management of the firm, which we define as all executive officers and directors in the firm such as the Chief Executive Officer, Chief Financial Officer, Chief Operations Officer, Chief Technology Officers and Vice-Presidents 4 .

3.2 Cash holdings Our first test is the association between corporate cash holdings, board characteristics and management equity ownership. CASHi,t = 0 + 1CEODUAL i,t-1 + 2OUTDIR i,t-1 + 3BODSIZE i,t-1 + 4MGTOWNi,t-1 + 5MGTOWNSQi,t-1 + 6MGTOWNSQi,t-1*CEODUALi,t-1 + 7MGTOWNSQi,t-1*OUTDIR i,t-1 + 8MGTOWNSQ i,t-1*BODSIZE i,t-1 9LOGASSETi,t-1 + 10LEVi,t-1 + 11CAPEXi,t-1 + 12NWCi,t-1 + 13CFFOi,t-1 + 14SALEGROWi,t-1 + 15DIVi,t-1 + 16ANTIDIRi,t-1 + Country Dummies + Year Dummies + Industry dummies respectively. Our central hypothesis is that if cash facilitates overinvestment by entrenched managers, firms with entrenched managers will hold more cash. A firms board of directors plays an important role in monitoring and constraining managerial discretion. Two important attributes of boards effectiveness are board size and board independence. The governance literature generally suggests that when boards are smaller and when board independence increases, their monitoring effectiveness increases, thereby decreasing managerial opportunism and enhancing firm
If the annual report discloses the ownership of family members of management (typically in the beneficial ownership section), we include the common stock ownership of family members in our measure of family ownership. To the extent that disclosure of family ownership differs across the countries, we acknowledge that our measure of management ownership is likely to be understated. However, this should bias against us from finding a result supporting our hypothesis.
4

(1)

All variables are defined in table 1. Subscripts i and t denote the firm and year

11

performance. Thus, we expect firms with strong board structure have low cash holdings. Prior studies suggest that strong boards are associated with separation of CEO and chairman positions, high proportion of outside directors and small board size. If strong boards reduce management propensity to hoard excessive cash, we predict the coefficients CEODUAL and BODSIZE to be positive and coefficient OUTDIR to be negative. From Jensen and Meckling (1976), Morck, Shleifer and Vishny (1988) and McConnell and Serveas (1990), we expect that at low managerial equity ownership, greater managerial equity ownership is associated with lower agency costs (alignment of interest effect) and at high managerial equity ownership, greater managerial equity ownership is associated with higher agency costs (entrenchment effect). If higher managerial entrenchment is associated with higher corporate cash holdings, then the coefficients on MGTOWN and MGTOWNSQ should be negative and positive respectively. To test whether board structure affects the association between cash holdings and high expected managerial entrenchment (proxied by MGTOWNSQ), we also interact MGTOWNSQ with various board attributes. If strong board structures reduce managerial entrenchment over corporate cash holdings, we expect the interaction term MGTOWNSQ*OUTDIR to be negative and the interaction terms MGTOWNSQ*CEODUAL and MGTOWNSQ *BODSIZE to be positive. Following, Opler et. al (1999), the remaining variables are economic determinants for holding cash such as liquidity needs, firm size, growth opportunities and capital investment plans. First, a certain level of cash holdings is required to support the daily operations of the firm, because cash cannot be raised instantaneously on a daily need basis. This transactions motive suggests that the size of the firm is a key determinant. We control for firm size with the natural logarithm of total assets (LOGASSET). To control for potential cash substitutes, we include a measure of other, non-cash liquid assets with working capital (NWC) used as a proxy. Other motives for holding cash include accumulating precautionary financial slack in anticipation of new investment opportunities when external finance is costly. Thus, we include controls for cash flow (CFFO), investment opportunities measured by sales growth (SALEGROW), capital expenditure needs (CAPEX), and financing needs measured by corporate leverage (LEV) and dividend payouts (DIV). To control for the effect of country-level investor protection on corporate cash reserves, we include the shareholder rights index from 12

La Porta et. al (1998), with higher values denoting stronger shareholder rights.We also include country indicators, year indicators and industry indicators to control for country-specific, time trend and industry effects respectively.

3.3 Firm value Next, we examine the association between corporate cash holdings, board characteristics and management equity ownership. TOBINQi,t = 0 + 1CASHi,t-1 + 2CEODUAL i,t-1 + 3OUTDIR i,t-1 + 4BODSIZE i,t-1 + 5MGTOWNi,t-1 + 6MGTOWNSQi,t-1 + 7CEODUAL i,t-1 * CASHi,t-1 + 8OUTDIR i,t-1 * CASHi,t-1 + 9BODSIZE i,t-1*CASHi,t-1 + 10MGTOWN i,t-1*CASHi,t-1 + 11MGTOWNSQ i,t-1*CASHi,t-1 + 12MGTOWNSQi,t-1*CASHi,t-1*CEODUALi,t-1 + 13MGTOWNSQi,t-1*CASHi,t-1*OUTDIRi,t-1 + 14MGTOWNSQi,t-1* CASHi,t-1*BODSIZE i,t-1 + 15LOGASSETi,t-1 + 16LEVi,t-1 + 17CAPEXi,t-1 + 18CFFOi,t-1 + 19ANTIDIRi,t-1 + Country Dummies + Year Dummies + Industry dummies (2) All variables are defined in Table 1. Subscripts i and t denote the firm and year respectively. The dependent variable is firm value that is proxied by the firms market-to-book ratio (TOBINQ). Prior studies suggest that firm value is positively associated with strong corporate governance structures. Thus, we predict the coefficients on OUTDIR and MGTOWN to be positive and the coefficients on CEODUAL, BODSIZE and MGTOWNSQ to be negative. More importantly, we expect the valuation of cash reserves will be higher in firms with stronger board structure. Thus, we predict the coefficients on CASH*OUTDIR to be positive and the coefficients on CASH*CEODUAL and CASH*BODSIZE to be negative. Furthermore, we predict that in firms with high expected managerial entrenchment, the valuation of cash reserves will be low. We predict a positive sign on the interaction CASH*MGTOWN and a negative sign on the interaction CASH*MGTOWNSQ. Finally, in firms with both high expected managerial entrenchment and high cash reserves, we predict that investors will incrementally discount the valuation of those firms with weak board structure. Hence, we predict the three-way interaction terms CASH*MGTOWNSQ*

13

CEODUAL and CASH*MGTOWNSQ* BODSIZE are negative and the interaction term CASH*MGTOWNSQ* OUTDIR is positive. The control variables are firm size (LOGASSET), corporate leverage (LEV), growth opportunities (CAPEX) and profitability (CFFO). We also include country indicators, year indicators and industry indicators to control for macro-economic, time trend and industry effects respectively.

3.4 Operating performance As an additional test, we examine the association between cash reserves and subsequent operating performance. Following Dittmar and Marht-Smith (2007), we hypothesize that firms that draw down their excess cash from year t 1 to year t will have lower operating performance if they have poor governance. Specifically, we examine the return on assets (ROA) for the sub-sample of firms that had positive excess cash at time t 1 and used some of it up in year t. We measure ROA as net income before tax divided by total assets net of cash. We estimate a regression of ROA on the level of excess cash at time t 1, governance at time t 1, and and interaction between the two. We control for size (net assets), asset structure (PP&E divided by net assets), lagged ROA, country effects and industry effects in these regressions. The regression equation is given as follows. ROAi,t = 0 + 1EXCASHi,t-1 + 2CEODUAL i,t-1 + 3OUTDIRi,t-1 + 4BODSIZE i,t-1 + 5MGTOWNi,t-1 + 6MGTOWNSQi,t-1 + 7CEODUAL
i,t-1

* EXCASHi,t-1 +

8OUTDIR i,t-1 * EXCASHi,t-1 + 9BODSIZE i,t-1*EXCASHi,t-1 + 10MGTOWN i,t-1*EXCASHi,t-1 + 11MGTOWNSQ i,t-1*EXCASHi,t-1 + 12MGTOWNSQi,t-1*EXCASHi,t-1*CEODUALi,t-1 + 13MGTOWNSQi,t-1* EXCASHi,t-1*OUTDIR i,t-1 + 14MGTOWNSQ
i,t-1*

EXCASHi,t-1*BODSIZE

i,t-1

+ 15Ln(NAi,t) + 16PPEi,t + (3)

17ROAi,t-1 + 18ANTIDIRi,t-1 +Country Dummies + Industry dummies

We estimate the ROA regression (3) on all firms that both have positive excess cash at date t 1 and reduce their cash between t 1 and t. A negative coefficient for excess cash (EXCASH) indicates that firms with excess cash will have lower subsequent profitability. A positive coefficient on the interaction term between lagged 14

excess cash and lagged governance indicates that for every dollar of excess cash held at date t 1, firms with weak corporate governance who used up excess cash experienced a lower ROA in the following year compared to firms with good corporate governance. Thus, we predict the interaction terms EXCASH*OUTDIR and EXCASH*MGTOWN should be positive and the interaction terms EXCASH*CEODUAL, EXCASH*BODSIZE and EXCASH*MGTOWNSQ should be negative. Finally, in firms with both high expected managerial entrenchment and high cash reserves, we predict that firms with strong board structure will have higher return on assets than those with weak board structure. Hence, we predict the threeway interaction terms EXCASH*MGTOWNSQ*CEODUAL and EXCASH*MGTOWNSQ*BODSIZE are negative and the three-way interaction term EXCASH*MGTOWNSQ* OUTDIR is positive.

4. Results 4.1 Summary statistics Table 1 reports the descriptive statistics. Cash holding has a mean of 0.124 and a median of 0.107, with a standard deviation 0.283. Because of the skewness of the variable, we use the log of cash holdings in our tests. In terms of financial data, the average firm in the sample has capital expenditure to asset ratio of 0.047, leverage of 0.156, net working capital (excluding cash) to assets of 0.134, cash flow from operations to assets of 0.122 and a one-year sales growth rate of 0.134. Turning to board characteristics, the CEO chairs the board in 51% of the firms, the mean board size is about 7 and the mean proportion of outside directors on the board is 47.2%. Mean management equity ownership is 0.19.

4.2 Cash holdings Table 2 reports the regression of cash holdings on various board attributes and corporate ownership structure. The dependent variable is the natural logarithm of the ratio of cash holdings to non-cash assets. In column (1), the coefficient on CEODUAL is positive and significant at the 5% level. This result suggests that firms with CEOs who also chair the board of directors have higher cash holdings. The coefficient on OUTDIR is negative and significant at the 1% level. This result suggests that firms with higher proportion of outside directors have lower cash holdings. Collectively, these results suggest that firms with higher board 15

independence (measured by the separation of the CEO and chairman of the board positions and the proportion of outside directors on the board) have lower levels of cash holdings. We also find that corporate cash holdings are positively associated with board size. This result is consistent with the notion that larger boards are associated with greater inefficiencies and coordination problems (Yermack 1996). Taken together, our results suggest that stronger boards are associated with more effective monitoring of managerial discretion over corporate cash holdings. The coefficient on management equity ownership (MGTOWN) is positive but statistically insignificant. Thus, there is no evidence of alignment of interest between managers and shareholders at low level of managerial equity ownership. In contrast, the coefficient on the squared term of management equity ownership (MGTOWNSQ) is positive and significant at the 5% level, implying that in firms with high level of managerial equity ownership, greater managerial equity ownership is associated with higher levels of cash beyond the economic determinants of corporate cash holdings. Because our regressions control for economic factors such as growth opportunities that are linked to the liquidity needs of a firm, the positive association between MGTOWNSQ and CASH indicates that at high level of managerial equity ownership, entrenched managers may be holding more cash to maximize their own utility. This result is consistent with the Morck, Shleifer and Vishnys (1988) argument that at high level of managerial equity ownership, greater managerial ownership is associated with greater managerial entrenchment. In our setting, the greater managerial entrenchment manifests in excessive corporate cash holdings, which may potentially lead to overinvestment in negative net present value projects 5 . The control variables are generally in their predicted directions. Corporate cash holdings are positively associated with growth opportunities (SALEGROW) and cash flow from operations (CFFO). In contrast, corporate cash holdings are negatively associated with capital expenditure (CAPEX), net working capital (NWC) and dividend payments (DIV).

We also test for non-monotonic relation between cash holding and managerial equity ownership by including an additional cubic term for the managerial equity ownership similar to the specification in Okzan and Okzan (2004). The coefficient of the cubic term for the managerial equity ownership is not statistically significant in all specifications.

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In column (2), we examine whether board structure affects the positive association between cash holdings and expected managerial entrenchment (proxied by the squared term of management equity ownership (MGTOWNSQ)). To accomplish this, we interact various board characteristics and MGTOWNSQ. The interaction term between MGTOWNSQ and CEODUAL is positive but statistically insignificant at conventional levels. More importantly, we find that the interaction term between MGTOWNSQ and OUTDIR is negative and significant at the 1% level. This result suggests that the positive association between cash holdings and high levels of management equity ownership is less pronounced in firms with higher proportion of outside directors. Hence, greater board independence mitigates entrenched managers propensity to hold larger cash reserves especially in firms with high expected agency costs arising from high levels of managerial ownership. We also find that the interaction term between MGTOWNSQ and BODSIZE is positive and significant at the 5% level. This result suggests that the positive association between cash holdings and high levels of management equity ownership is more pronounced in firms with larger boards. Hence, in firms with high managerial equity ownership, those with larger boards hold higher cash reserves. In other words, large board size exacerbates entrenched managers ability to hold high cash reserves. Collectively, our results are consistent with the hypothesis that firms with higher expected managerial entrenchment, those with stronger board structures hold lower cash reserves.

4.3 Firm value In this section, we examine the association between firm value and corporate cash holdings. Table 3 presents the results of regressions of firm valuation on cash holdings, board structure and ownership. Our proxy for firm value is TOBINQ, which is measured as the market value of common equity and book value of total liabilities divided book value of total assets. In column (1), we find that firm value is positively associated with the proportion of outside directors on the board and negatively associated with board size. These results are consistent with prior studies that suggest that greater board independence and smaller boards are associated with stronger monitoring of managers and hence higher firm valuation (Mehran 1995, Yermack 1996). Although the estimated coefficients on CEODUAL and MGTOWN are in the predicted direction, they are not statistically significant. The coefficient of 17

MGTOWNSQ is negative and significant at the 5% level, implying that at high level of managerial ownership, the entrenchment effect of managerial equity ownership dominate the incentive alignment effects, resulting in lower firm valuation. Our result is consistent with the Morck, Shleifer and Vishnys (1988) argument that high managerial equity ownership concentrates managerial voting rights, resulting in greater private benefits of control. The estimated coefficient for CASH is negative and significant at the 1% level, indicating that firms with low cash holdings have high firm valuation. The interaction between CASH and CEODUAL, OUTDIR or BODSIZE tests the incremental effect of board structures on the association between firm valuation and cash reserves. The interaction between CASH and OUTDIR is positive and significant at the 5% level, suggesting that firm valuation is higher when firms hold higher cash reserves and managers are subjected to stronger monitoring by outside directors. Furthermore, the interaction between CASH and BODSIZE is negative and significant at the 1% level. This result indicates show that having larger boards (weak governance) substantially and significantly decreases the value of cash. The interaction between CASH and CEODUAL is negative but insignificant. The interaction between CASH and MGTOWNSQ is negative and significant at the 5% level, suggesting that more entrenched managers (proxied by high level of managerial equity ownership) substantially and significantly decreases the value of cash. Collectively, we show that the value the stock market assigns to a dollar of cash is greater for a well-governed firm relative to a poorly-governed firm. Our finding that there is valuation benefit to holding cash when firm-level corporate governance is strong is broadly consistent with the results in Pinkowitz et. al (2006) and Dittmar and Marht-Smith (2007). In column (2), we examine how board structure affects the association between firm valuation and cash holdings in firms with entrenched managers. To test this hypothesis, we regress firm valuation (TOBINQ) on interactions between cash holdings (CASH), managerial entrenchment (proxied by MGTOWNSQ), and board characteristics (such as CEODUAL, OUTDIR or BODSIZE). We find results consistent with our hypothesis. The stand-alone coefficient on CASH is negative and significant (0.201, t-statistic = 4.35) and the MGTOWNSQ * CASH interaction coefficient is negative and significant (0.985, t-statistic = -2.09). The negative 18

interaction coefficient indicates that investors discount the cash held by firms with managers that are expected to be entrenched. Further, the three-way interaction between MGTOWNSQ, CASH and OUTDIR has a positive and significant coefficient (0.746, t-statistic =2.40). This coefficient indicates that investors incrementally discount the value of firms with high cash and entrenched managers when board monitoring by outside directors is weak. These results are economically significant as well. For a firm with the mean CASH ratio of 0.12, a decline in the proportion of outside directors on the board (OUTDIR) from 0.64 to 0.30 and a rise in managerial equity ownership (MGTOWN) from the 25th percentile (0.09) to the 75th percentile (0.35) corresponds to a 0.017 decline in TOBINQ 6 . With a mean sample TOBINQ of 1.386, this corresponds to a 1.2% reduction in TOBINQ on average. The three-way interaction between MGTOWNSQ, CASH and BODSIZE has a negative and significant coefficient (-0.032, t-statistic =-2.06). This coefficient indicates that in firms with both high cash and entrenched managers, firm valuation is lower when board size is higher. These results are economically significant as well. For a firm with the mean CASH ratio of 0.12, an increase in board size (BODSIZE) from 5 to 9 and a rise in managerial equity ownership (MGTOWN) from the 25th percentile (0.09) to the 75th percentile (0.35) corresponds to a 0.0152 decline in TOBINQ 7 . With a mean sample TOBINQ of 1.386, this corresponds to a 1.1% reduction in TOBINQ on average.

The MGTOWNSQ * CASH coefficient shows that a change in managerial equity ownership from 0.09 to 0.35 is associated with a 0.01352 lower TOBINQ value (-0.985 x [ (0.35)2 (0.09)2 ] x 0.12 = 0.01352). The MGTOWNSQ * CASH * OUTDIR coefficient shows that a change in managerial equity ownership from 0.09 to 0.35 for an average-cash-level firm from a firm with OUTDIR of 0.30 corresponds to a 0.00348 lower TOBINQ value compared to a similar firm from OUTDIR of 0.64 = (0.746 x 0.12 x [ (0.35)2 - (0.09)2 ] x (0.30-0.64 ) = -0.0034. Summing up, the net effect is a reduction in TOBINQ of 0.017 (= 0.01352 -0.0034) The MGTOWNSQ * CASH coefficient shows that a change in managerial equity ownership from 0.09 to 0.35 is associated with a 0.01352 lower TOBINQ value (-0.985 x [ (0.35)2 (0.09)2 ] x 0.12 = 0.01352). The MGTOWNSQ * CASH * BODSIZE coefficient shows that a change in managerial equity ownership from 0.09 to 0.35 for an average-cash-level firm from a firm with BODSIZE of 9 corresponds to a 0.00176 lower TOBINQ value compared to a similar firm from BODSIZE of 5 = (0.032 x 0.12 x [ (0.35)2 - (0.09)2 ] x (0.30-0.64 ) = 0.00176. Summing up, the net effect is a reduction in TOBINQ of 0.0152 (= 0.01352 0.00176).
7

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Excess cash In the previous analysis, we focus on the total cash, and we show that (i) poorly governed firms have higher cash holdings and (ii) investors discount firms with high cash holdings when corporate governance is weak. As a robustness test, we extend our measure of cash to consider the effects of governance on the valuation of excess cash. Following Dittmar and Smith (2007), we define excess cash as cash held by firms that is not needed for firm operations or investments. Total cash does not account for the fact that managers may be less likely to waste cash resources needed for daily operations. As in Dittmar and Smith (2007), we define excess cash as the cash held above a predicted optimal (or necessary) level of cash. We estimate this optimal level using a regression of cash on variables that proxy for legitimate reasons firms hold cash such as investment opportunities, hedging needs and availability of alternative sources of liquidity. Following the regression specifications for an optimal cash regression in prior literature (Opler, Pinkowitz, Stulz, and Williamson, 1999; Dittmar, Mahrt-Smith, and Servaes, 2003; Dittmar and Smith (2007)), we estimate the optimal cash regression as follows:Ln(CASH) = 0 + 1Ln(NA) + 2FCF + 3NWC + 4SALEGROW + Year Dummies + Country Dummies + Industry dummies (4) Where CASH = cash divided by net assets. NA = total assets less cash. FCF = (cash flow less capital expenditure less interest expense) divided by net assets NWC = (current assets less current liabilities less cash divided) by net assets SALEGROW = prior year sales growth. The residuals from the above equation are used to compute excess cash. Table 4 presents the results of regressions of firm valuation on excess cash and corporate governance measures. Our results are qualitatively similar. For parsimony, we focus our analysis based on the results in column (2). Firm valuation is positively associated with excess cash. The interaction term OUTDIR and EXCASH is positive and significant. Thus, in firms with excess cash, investors assign higher valuation to those firms with higher proportion of outside directors. The interaction term BODSIZE and EXCASH is negative and significant, suggesting that firm values are lower when firms have higher level of excess cash and larger board size. The interaction term MGTOWNSQ and EXCASH is negative and significant, implying 20

that when managers are entrenched, investors discount firm value in firms with high excess cash reserves. The three-way interaction between MGTOWNSQ, EXCASH and OUTDIR is positive and significant. Thus, the negative association between firm value and excess cash in firms with entrenched managers is mitigated by the proportion of outside directors on the board. In other words, greater monitoring associated with higher board independence reduces the valuation of excess cash in firms with high expected managerial entrenchment. Moreover, the three-way interaction between MGTOWNSQ, EXCASH and BODSIZE is negative and significant. Thus, the negative association between firm value and excess cash in firms with entrenched managers is more pronounced when firms have larger board of directors. Stated differently, in firms with excess cash, large boards exacerbate agency costs associated with managerial entrenchment 8 .

4.4 Operating performance We now examine the operating performance of all firms that both have positive excess cash at year t-1 and reduce their cash between year t-1 and year t. This subsample of firms represents firms with excess cash beyond their normal needs and then subsequently spend their cash during the year. We focus on this sub-sample to test the influence of governance on the value of cash reserves not needed for operations and investments. Table 5 presents the results of estimating regression (3) that was previously discussed in section 3. In column (1), the coefficient on the stand-alone lagged excess cash (EXCASHi,t-1) shows that for firms that use excess cash holdings over the year, a larger beginning balance of excess cash results in lower future operating performance. The interaction OUTDIR i,t-1 * EXCASHi,t-1 is positive and significant, suggesting that the negative association between future return on assets and beginning balance of excess cash is mitigated in firms with high proportion of outside directors on the board. The interaction BODSIZEi,t-1 * EXCASHi,t-1 is negative

Kalcheva and Lins (2008) find that negative association between firm valuation and managerial entrenchment is mitigated in firms that pay dividends. Thus, as a robustness check of the mitigating role of dividends, we include the interaction between our proxy for managerial entrenchment and dividend payout measured as dividend paid divided by net profit after tax. Consistent with Lins and Kalcheva (2008), we also find that dividend payout mitigates the negative association between firm valuation and managerial entrenchment. More importantly, our primary result - stronger board structure (i.e. smaller boards and higher board independence) mitigates mitigates the negative association between firm valuation and managerial entrenchment continues to hold.

21

and significant, suggesting that the negative association between future return on assets and beginning balance of excess cash is more pronounced in firms with larger boards. We also document that subsequent operating performance deteriorates in firms with high excess cash and high expected managerial entrenchment, as evidenced by the negative interaction term MGTOWNSQ i,t-1 * EXCASHi,t-1. In column (2), we extend our model to test whether the negative association between subsequent operating performance and excess cash in firms with expected managerial entrenchment is mitigated by stronger board structure. Specifically, the positive and significant coefficient on the three-way interaction term (MGTOWNSQi,t-1* EXCASHi,t-1*OUTDIR i,t-1 ) suggests that in firms with high excess cash and high expected managerial entrenchment, those with higher proportion of outside directors on the board have better subsequent operating performance. Furthermore, there is some evidence that in firms with high excess cash and high expected managerial entrenchment, subsequent operating performance worsens when such firms have larger boards, as evidenced by the negative and significant coefficient on the threeway interaction term (MGTOWNSQi,t-1* EXCASHi,t-1* BODSIZE i,t-1 ) Collectively, our results indicate that the negative association between subsequent operating performance and excess cash in firms with expected managerial entrenchment is mitigated in firms with stronger board structure.

5. Conclusions In this study, we examine the relation among cash holding, corporate governance structures and firm valuation. Using a large sample of listed firms in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand), we find that firms with higher board independence, smaller boards, and higher expected managerial entrenchment, have lower cash holdings. Our results are consistent with Jensens (1986) theory that the conflicts between managers and shareholders over the deployment of corporate resources are higher when firms have larger free cash flow. In poorly governed firms, self-interested managers pursue private benefits of control by holding excessive cash and overspending cash on value-destroying projects. We find that the negative association between cash holdings and managerial entrenchment is mitigated by stronger board structures. Specifically, in firms with higher expected

22

managerial entrenchment, those with higher proportion of outside director on the board and smaller board size have lower cash holdings. We document that firm value is negatively associated with cash levels. The negative association between firm value and cash holdings is more pronounced in firms with (i) lower proportion of outside directors, (ii) larger boards and (iii) higher expected managerial entrenchment. These results suggest that agency costs of free cash flow are exacerbated when corporate governance structure is weak, resulting in additional decline in firm valuation. Finally, we find that in firms with both high cash holdings and high expected managerial entrenchment, investors additionally discount the valuation of firms with lower proportion of outside directors and those with larger boards. Our results are qualitatively similar using subsequent profitability as a measure of firm performance. Firms with higher excess cash have lower subsequent profitability. The negative association between subsequent profitability and cash holdings is more pronounced in firms with weaker board structure.

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References Claessens, Stijn, Simeon Djankov, and Larry H.P. Lang, 2000, The separation of ownership and control in East Asian corporations, Journal of Financial Economics 58, 81112. Dittmar, A., Mahrt-Smith, J., 2007, Corporate governance and the value of cash holdings, Journal of Financial Economics 83, 599-634. Dittmar, A., Mahrt-Smith, J., Servaes, H., 2003, International corporate governance and corporate cash holdings, Journal of Financial and Quantitative Analysis 38, 111-133. Harford, J., 1999. Corporate cash reserves and acquisitions. Journal of Finance 54, 1969 1997. Harford, J., Li, K., 2007. Decoupling CEO wealth and firm performance: the case of acquiring CEOs. Journal of Finance 62, 917949. Jensen, M., 1986. Agency costs of the free cash flow, corporate finance and takeovers. American Economic Review 76, 323329. Jensen, M., Meckling, W., 1976. Theory of the firm: managerial behavior, agency costs and ownership structure, Journal of Financial Economics 3, 305360. Kim, C., Mauer, D., Sherman, A., 1998, The determinants of corporate liquidity: theory and evidence, Journal of Financial and Quantitative Analysis 33, 335-359. La Porta, R., Lopez-De-Silanes, F., Shleifer, A., Vishny, R., 2000. Investor protection and corporate governance. Journal of Financial Economics 58, 327. Lins, K., Kalcheva, I., 2007. International evidence on cash holdings and expected managerial agency problems. Review of Financial Studies, 1087-1112. McConnell, J.J., Servaes, H., 1990. Additional evidence on equity ownership and corporate value. Journal of Financial Economics 27, 595612. Mikkelson, W., Partch, M., 2003. Do persistent large cash reserves hinder performance? Journal of Financial and Quantitative Analysis 38, 275294. Morck, R., Shleifer, A., Vishny, R., 1988. Management ownership and market valuation: An empirical analysis. Journal of Financial Economics 20, 293315. Ozkan, A., Ozkan, N., 2004, Corporate cash holdings: An empirical investigation of UK companies, Journal of Banking and Finance 28, 2103-2134. Opler, T., Pinkowitz, L., Stulz, R., Williamson, R., 1999. The determinants and implications of corporate cash holdings. Journal of Financial Economics 52, 346. Pinkowitz, L., Williamson, R., 2001, Bank power and cash holdings: Evidence from Japan, Review of Financial Studies 14, 1059-1082. Pinkowitz, L., Stulz, R., Williamson, R., 2006, Does the contribution of corporate cash holdings and dividends to firm value depend on governance? A cross-country analysis, Journal of Finance 61, 2725-2752.

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Shleifer, A., Vishny, R., 1986. Large shareholders and corporate control. Journal of Political Economy 94, 461488. Shleifer, A., Vishny, R., 1997. A survey of corporate governance. Journal of Finance 52, 737 783. Stulz, R., 1990. Managerial discretion and optimal financing policies. Journal of Financial Economics 26, 327. Yermack, D., 1996. Higher market valuation companies with a small board of directors. Journal of Financial Economics 40, 185212.

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Table 1 Descriptive statistics Mean CASH LOGASSET CAPEX LEV NWC CFFO DIV TOBINQ ROA CEODUAL OUTDIR BODSIZE MGTOWN ANTIDIR 0.124 11.352 0.047 0.156 0.134 0.122 0.661 1.386 0.032 0.509 0.472 7.455 0.194 3.759 25th percentile 0.021 10.345 0.012 -0.009 -0.0148 0.006 -0.055 0 0.634 0.002 0 0.302 5 0.092 2 0.107 11.137 0.028 0.136 0.121 0.052 0.075 1 1.185 0.041 1 0.457 8 0.120 3 Median 75th percentile 0.259 12.172 0.063 0.304 0.289 0.106 0.232 1 1.544 0.087 1 0.640 9 0.353 4 Standard deviation 0.283 1.366 0.052 0.205 0.223 0.834 0.387 0.473 1.018 0.106 0.485 0.233 3.181 0.172 1.362

SALEGROW 0.134

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Table 1 (continued) Variable definitions CASH = Cash and short-term investments divided by net assets. Net assets are total assets minus cash and short term investments LOGASSET CAPEX LEV NWC = = = = Natural logarithm of total assets. Capital expenditure divided by total assets. (Total debt less cash ) divided by total assets Net working capital divided by net assets. liabilities. CFFO SALEGROW DIV TOBINQ ROA CEODUAL OUTDIR = = = = = = = Cash flow from operations divided by total assets. On-year sales growth rate. A dummy variable that equals one if the firm pays dividend in the fiscal year and zero otherwise. Market value of equity plus book value of total liabilities divided by total assets. Net income before tax divided by total assets. A dummy variable that equals one if the CEO is also the chairman of the board and zero otherwise. Proportion of outside directors on the board where an outside director is defined as a director who is not a current nor former employee of the firm. BODSIZE MGTOWN = = Total number of directors on the board. Proportion of common equity held by the executive officers and directors in the firm. MGTOWNSQ = ANTIDIR = Squared term of MGTOWN. Country-level shareholder protection from LaPorta et. Al (1998) with higher values denoting stronger shareholder protection. Net working capital is current assets less cash and equivalents less current

27

Table 2 Regression of cash holdings on board structure and management ownership The sample consists of 1,061 firms for 4,206 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand). The dependent variable is the natural logarithm of CASH, measured as the ratio of cash to non-cash assets. All variables are defined in Table 1. All models include country, year and industry indicators and an intercept term (not tabulated). Tstatistics based on clustered standard errors at the firm level are reported in parentheses below the coefficient. *,** and *** indicate significance at the 10%, 5% and 1% respectively. CEODUAL OUTDIR BODSIZE MGTOWN MGTOWNSQ MGTOWNSQ * CEODUAL MGTOWNSQ * OUTDIR MGTOWNSQ * BODSIZE LOGASSET LEV CAPEX NWC CFFO SALEGROW DIV ANTIDIR Number of observations R-squared Sign + + + + + + + + 0.002 (0.18) -2.049 (-8.64)*** -0.051 (-0.21) -0.545 (-6.75)*** 0.004 (1.49) 0.075 (2.53)** -0.093 (-2.73)*** -0.041 (-2.02)** 4,223 0.175 1 0.086 (2.56)** -1.006 (-4.09)*** 0.0484 (3.72)*** 0.223 (0.62) 0.868 (3.10)*** 2 0.081 (2.45)** -0.980 (-3.84)*** 0.046 (4.30)*** 0.221 (0.63) 0.851 (2.97)*** 0.279 (1.47) -0.175 (-3.78)*** 0.206 (-2.19)** 0.008 (0.59) -2.166 (-9.18)*** -0.645 (-2.44)** -0.568 (-3.19)*** 0.003 (1.17) 0.028 (0.95) -0.086 (-2.52)** -0.038 (-1.86)* 4,223 0.192

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Table 3 Regression of firm value on cash holdings and corporate governance structures
The sample consists of 1,061 firms for 4,206 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand). The dependent variable is firm value (TOBINQ), computed as market value of equity plus book value of total liabilities divided by total assets. All variables are defined in Table 1. All models include country, year and industry indicators and an intercept term (not tabulated). Tstatistics based on clustered standard errors at the firm level are reported in parentheses below the coefficient. *,** and *** indicate significance at the 10%, 5% and 1% respectively.

CASH CEODUAL OUTDIR BODSIZE MGTOWN MGTOWNSQ CEODUAL * CASH OUTDIR* CASH BODSIZE* CASH MGTOWN * CASH MGTOWNSQ * CASH MGTOWNSQ * CASH * CEODUAL MGTOWNSQ * CASH * OUTDIR MGTOWNSQ * CASH * BODSIZE LOGASSET CAPEX LTD CFFO ANTIDIR Number of observations R-squared

+ + + + + + + + +

1 -0.231 (-3.95)*** 0.167 (0.45) 0.089 (2.25)** -0.004 (-1.85)* 0.217 (0.31) -0.067 (-2.01)** -0.188 (-0.54) 0.886 (2.13)** -0.479 (-2.86)*** 0.005 (0.06) -0.873 (-2.05)**

0.064 (1.77)* 2.197 (3.24)*** 0.966 (0.62) 0.017 (4.03)*** 0.0815 (2.13)** 4,206 0.062

2 -0.201 (-4.35)*** 0.145 (0.12) 0.092 (2.01)** -0.004 (-1.84)* 0.112 (0.16) -0.055 (-2.12)** -0.189 (-0.55) 0.817 (2.09)** -0.356 (-2.65)*** 0.020 (0.19) -0.985 (-2.09)** 0.328 (0.94) 0.746 (2.40)*** -0.032 (-2.06)** 0.044 (1.26) 3.591 (5.45)*** 1.365 (1.16) 0.013 (3.79)*** 0.0627 (2.02)** 4,206 0.087 29

Table 4 Regression of firm value on excess cash holdings

The sample consists of 1,061 firms for 4,206 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand). The dependent variable is firm value (TOBINQ), computed as market value of equity plus book value of total liabilities divided by total assets. EXCASH is the excess cash based on the residuals computed in equation (4). All variables are defined in Table 1. All models include country, year and industry indicators and an intercept term (not tabulated). T-statistics based on clustered standard errors at the firm level are reported in parentheses below the coefficient. *,** and *** indicate significance at the 10%, 5% and 1% respectively.

EXCASH CEODUAL OUTDIR BODSIZE MGTOWN MGTOWNSQ CEODUAL * EXCASH OUTDIR* EXCASH BODSIZE* EXCASH MGTOWN * EXCASH MGTOWNSQ* EXCASH MGTOWNSQ * EXCASH * CEODUAL MGTOWNSQ * EXCASH * OUTDIR MGTOWNSQ * EXCASH * BODSIZE LOGASSET CAPEX LTD CFFO ANTIDIR
Number of observations R-squared

+ + + + + + + + +

1 -0.087 (-2.71)*** -0.009 (-0.11) 0.179 (2.11)** -0.011 (-1.78)* 0.532 (0.46) 0.112 (-2.01)** 0.089 (0.19) 0.068 (1.98)** -0.452 (-2.25)** 0.047 (0.35) -0.739 (-2.86)***

0.079 (1.03) 2.629 (2.87)*** 0.871 (0.70) 0.701 (1.12) 0.605 (1.93)*
4,206 0.073

2 -0.072 (-2.24)** -0.015 (-0.17) 0.164 (2.02)** -0.012 (-1.29) 0.463 (0.59) -0.121 (-2.08)** 0.085 (0.17) 0.885 (2.06)** -0.356 (-2.17)** 0.034 (0.25) -0.816 (-2.71)*** -0.299 (-0.75) 0.157 (2.59)*** -0.204 (-2.20)** 0.062 (0.38) 1.819 (2.12)** 0.253 (0.65) 0.372 (0.36) 0.581 (1.91)*
4,206 0.085

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Table 5 Regression of subsequent operating performance on excess cash holdings. The sample consists of 1,153 firm-year observations during the period 2001 to 2005 in five Asian countries (Malaysia, Philippines, Indonesia, Singapore and Thailand) that have both positive excess cash in year t-1 and subsequently reduce their cash holdings between year t-1 to year t. The dependent variable is return on assets (ROA), computed net income before tax divided by total assets. EXCASH is the excess cash based on the residuals computed in equation (4). All variables are defined in Table 1. All models include country, year and industry indicators and an intercept term (not tabulated). T-statistics based on clustered standard errors at the firm level are reported in parentheses below the coefficient. *,** and *** indicate significance at the 10%, 5% and 1% respectively.
EXCASH t-1 CEODUAL t-1 OUTDIR t-1 BODSIZE t-1 MGTOWN t-1 MGTOWNSQ t-1 CEODUAL t-1 * EXCASH t-1 OUTDIR t-1* EXCASH t-1 BODSIZE t-1* EXCASH t-1 MGTOWN t-1* EXCASH t-1 MGTOWNSQ t-1* EXCASH t-1 MGTOWNSQ t-1* EXCASH t-1* CEODUAL t-1 MGTOWNSQ t-1* EXCASH t-1* OUTDIR t-1 MGTOWNSQ t-1 * EXCASH t-1* BODSIZE t-1 LOG(NA) t PPE t ROA t-1 ANTIDIR Number of observations R-squared + + + + + + + + 0.006 (2.59)*** 0.054 (1.26) 0.119 (2.40)** 0.317 (0.82) 1,153 0.231 1 -0.003 (-2.29)** 0.002 (0.29) 0.104 (2.29)** -0.004 (-2.03)** -0.011 (-0.12) -0.091 (2.17)** -0.044 (-1.02) 0.019 (3.22)*** -0.430 (-2.03)** 0.175 (1.36) -0.139 (-2.03)** 2 -0.002 (-2.13)** 0.004 (0.51) 0.101 (3.20)*** -0.005 (-2.01)** 0.008 (0.11) -0.089 (-2.28)** -0.048 (-1.10) 0.018 (2.93)*** -0.417 (-3.12)*** 0.226 (0.87)** -0.132 (-2.10)** 0.002 (0.25) 0.003 (2.08)** -0.129 (-1.77)* 0.011 (2.93)** 0.038 (0.72) 0.117 (2.35)** 0.502 (1.28) 1,153 0.0254

31