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Valuation Effects of Corporate Cash Holdings

Brandorf, Christoffer and Holmberg, Johan (2011)
Department of Business Administration
Abstract
Corporate cash holdings have an important role in the financial management of corporations. Firms hold cash for various reasons, Keynes (1936) states the reasons to be of transaction, precautionary and speculative nature, respectively, and firms’ cash policies differ both on an industry and firm level. Previous empirical studies mainly deal with the determinants and behavior of corporate cash holdings however, studies on the effects of corporate cash holdings on firm valuation are rare. Reimund/Schwetzler (2004) investigate the relationship between corporate cash holdings and excess valuation for firms on the German market by creating excess enterprise values of firms, adapting a valuation algorithm constructed by Berger/Ofek (1995). We... (More)
Corporate cash holdings have an important role in the financial management of corporations. Firms hold cash for various reasons, Keynes (1936) states the reasons to be of transaction, precautionary and speculative nature, respectively, and firms’ cash policies differ both on an industry and firm level. Previous empirical studies mainly deal with the determinants and behavior of corporate cash holdings however, studies on the effects of corporate cash holdings on firm valuation are rare. Reimund/Schwetzler (2004) investigate the relationship between corporate cash holdings and excess valuation for firms on the German market by creating excess enterprise values of firms, adapting a valuation algorithm constructed by Berger/Ofek (1995). We apply a similar method for firms listed on the Swedish market (Affärsvärldens Generalindex, AFGX). We use two proxies for the optimal level of cash to sales: i) the industry median and ii) an average weighted by market capitalization. We find that the level of corporate cash holdings significantly affects firm valuation. Our results indicate that positive cash to sales deviations from both industry benchmarks has a positive effect on excess enterprise value. Negative cash to sales deviations have a negative effect on excess enterprise value, but only when using the weighted average as industry benchmark. Our results fail to support the joint hypothesis, in line with the trade-off theory, that any deviation in firms’ cash to sales ratio relative an industry benchmark ought to have a negative effect on excess enterprise value. Overall, we conclude that firms should not overlook the level of cash holdings, due to significant effects on firm valuation. Thus, a firm’s cash policy plays a role of importance in the shareholder value creation. (Less)
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author
Brandorf, Christoffer and Holmberg, Johan
supervisor
organization
year
type
H1 - Master's Degree (One Year)
subject
keywords
Corporate cash holdings, Valuation, Excess value, Trade-off theory, Pecking order theory, Management of enterprises, Företagsledning, management
language
Swedish
id
1982666
date added to LUP
2011-06-03
date last changed
2012-04-02 19:00:22
@misc{1982666,
  abstract     = {Corporate cash holdings have an important role in the financial management of corporations. Firms hold cash for various reasons, Keynes (1936) states the reasons to be of transaction, precautionary and speculative nature, respectively, and firms’ cash policies differ both on an industry and firm level. Previous empirical studies mainly deal with the determinants and behavior of corporate cash holdings however, studies on the effects of corporate cash holdings on firm valuation are rare. Reimund/Schwetzler (2004) investigate the relationship between corporate cash holdings and excess valuation for firms on the German market by creating excess enterprise values of firms, adapting a valuation algorithm constructed by Berger/Ofek (1995). We apply a similar method for firms listed on the Swedish market (Affärsvärldens Generalindex, AFGX). We use two proxies for the optimal level of cash to sales: i) the industry median and ii) an average weighted by market capitalization. We find that the level of corporate cash holdings significantly affects firm valuation. Our results indicate that positive cash to sales deviations from both industry benchmarks has a positive effect on excess enterprise value. Negative cash to sales deviations have a negative effect on excess enterprise value, but only when using the weighted average as industry benchmark. Our results fail to support the joint hypothesis, in line with the trade-off theory, that any deviation in firms’ cash to sales ratio relative an industry benchmark ought to have a negative effect on excess enterprise value. Overall, we conclude that firms should not overlook the level of cash holdings, due to significant effects on firm valuation. Thus, a firm’s cash policy plays a role of importance in the shareholder value creation.},
  author       = {Brandorf, Christoffer and Holmberg, Johan},
  keyword      = {Corporate cash holdings,Valuation,Excess value,Trade-off theory,Pecking order theory,Management of enterprises,Företagsledning, management},
  language     = {swe},
  note         = {Student Paper},
  title        = {Valuation Effects of Corporate Cash Holdings},
  year         = {2011},
}