Cash Holding and Corporate Performance
University van AmsterdamAmsterdam 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
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.
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.
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.
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.
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-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
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.
Chapter 3: Model
The regression model of this paper is as follow:
𝑅𝑂𝐴 = 𝛽&+ 𝛽(𝐶𝑎𝑠ℎ + 𝛽-𝐴𝑏𝑠𝑜𝑟𝑏𝑒𝑑 𝑠𝑙𝑎𝑐𝑘 + 𝛽7𝐷𝑒𝑏𝑡 𝑟𝑎𝑡𝑖𝑜 + 𝛽;𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑡𝑒𝑛𝑠𝑖𝑡𝑦 + 𝛽?𝐹𝑖𝑟𝑚 𝑠𝑖𝑧𝑒 + 𝛽C𝑅𝑒𝑐𝑒𝑠𝑠𝑖𝑜𝑛 ∗ 𝐶𝑎𝑠ℎ + 𝜀
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 firm’s 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
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
Exor Investment Italy
GlaxoSmithKline Pharmaceuticals United Kingdom
Nestlé 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
Telefónica 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
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
Chart of Cash to Asset Ratio
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 cash log Absorbed slack Debt ratio
Capital intensi ty Size reces sion* cash ROA 0.012 0.015 1 cash log 3.807 0.508 -0.0957 1 Absorbed slack 0.825 0.112 -0.353 -0.0561 1 Debt ratio 0.262 0.121 -0.181 0.0513 -0.271 1 Capital intensity 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
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 Patel’s paper can be explained by the difference between the Europe and the U.S. market. In particular, Nason and Patel’s 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
different conclusion.
Table 3
Regression analysis 1
independent Variables Coefficient t-Statistic P-value
Log Cash -0.0027 -2.26 0.024 Absorbed Slack -0.0701 -21.77 0.000 Debt Ratio -0.0295 -11.63 0.000 Capital Intensity -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 Patel’s conclusions, which is during the recession period, it shows more benefits for firms to hold cash. It draws the same conclusion as the previous
Table 4
Regression analysis 2
independent Variables Coefficient t-Statistic P-value
Log Cash -0.0025 -2.04 0.041 Absorbed Slack -0.0695 -21.58 0.000 Debt Ratio -0.0292 -11.49 0.000 Capital Intensity -0.0274 -12.34 0.000 Size 0.00046 0.32 0.751 Recession*Log Cash 0.00059 3.07 0.002 _cons 0.0885 18.49 0.000 Observation 1998 F (6, 1991) 115.15 R-squared 0.2931
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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