The Impact Of Cash Sources On The Cash Holdings Value Study

Although the literature shows the importance of cash sources on corporate cashholdings, no literature ever evaluates the effect of cash sources on the value of cashholdings. This study examines the value of additional cash and its variation withrespect to if the cash is generated from corporate operating (CFO), investment (CFI),and financing (CFF) activities. The empirical results show that the marginal value ofcash holdings and the marginal rate of change in cash value vary with cash fromdifferent corporate activities. Specifically, the marginal value of cash from CFO ishigher than the marginal value of cash from CFI or CFF, but the marginal rate ofchange in cash value decrease more if cash is from CFO. The findings suggest thatprofitable firms have lower incentive and potentially higher agency problem concernwhen accumulating cash internally. Extending the literature identifying higher cashvalue in financially constrained firms and in poorly governed firms, we find that theeffect of financial constraints would occur only if cash is not from CFO and the effectof poor governance would occur only if cash is from CFO. Overall, the agencyexplanation to the value of cash holdings is more pronounced in firms with highercapability of generating cash internally. For firms with better access to externalfinancing for cash holdings, the value of cash holdings is highly determined by theeconomical rationales of holding large cash.The contribution of this study is two-fold. First, this study contributes to therelated literature by analyzing the marginal value of corporate cash holdings throughthe sources of cash while the literature focuses on the potential uses of cash. Theliterature find that constrained firms have higher marginal value of cash and the fasterdeclining marginal value of cash holdings than unconstrained firms. Our study findthat this effect is only consistently observed when the additional cash accumulatedfrom CFI and CFF. It is not necessary to see higher marginal value of cash from CFOin constrained firms than in unconstrained firms. This finding indicates thatshareholders are still concerned with the cash accumulation internally for profitablefirms. Overall, the agency explanation to the value of cash holdings is morepronounced in firms with higher capability of generating cash internally. For firmswith better access to external financing for cash holdings, the value of cash holdings is highly determined by the economical rationales of holding large cash. Second, theconsideration of different cash flow components in examining the marginal value ofcorporate cash holdings provide investors with clear contents of information fromfinancial statements. Since the effects of different cash components on firm valueshould be different, thus understanding the value contribution of different cashcomponents may not only help firms better determining their cash holding policy topursue firm value maximization, but also help the financial markets interpretingmanagerial decisions and predicting the long-term implication of these decisions.