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The impact of banking relationships, managerial incentives, and board monitoring on corporate cash holdings: an emerging market perspective

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Abstract

This paper uses Taiwanese data to examine the impact of firm-level corporate governance mechanisms on firms’ average cash holdings. Specifically, it examines how a firm’s number of banking relationships and the percentages of managerial ownership and board ownership impact the firm’s level of cash holdings. We document that higher percentages of managerial ownership and board ownership are associated with higher levels of corporate cash holding. Our results are consistent with the notion that managerial incentives and board monitoring are substitutes for each other. The substitution effect is especially pronounced when firms have poorly incentivized managers. We find that firms with a larger number of banking relationships are associated with lower levels of cash holdings. We find no evidence of a bank monitoring free rider problem. We also document a life-cycle effect in the drivers of cash holdings: there are substantial differences in the drivers of cash holdings for firms that have been in business for more than 5 years relative to those that have not been in business less than 5 years.

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Notes

  1. Taiwanese firms are traditionally characterized by a high degree of ownership concentration, and have a concentrated managerial ownership of 28 %, because many of them are family-affiliated or relative-affiliated firms.

  2. Some key papers include Leland and Pyle (1977), Campbell and Kracaw (1980), Diamond (1984), James (1987), Lummer and McConnell (1989), and Hoshi et al. (1990).

  3. See Diamond (1984), Boyd and Prescott (1986), Berlin and Loeys (1988), increased access to private information Fama (1985), and the ease of liquidation and renegotiation of loan terms in the event of financial distress Chemmanur and Fulghieri (1994), Gertner and Scharfstein (1991). In contrast Rajan (1992) documents that private lenders can have a negative impact on borrowers by extracting rents and distorting managerial incentives.

  4. See Smith and Warner (1979), Fama (1985), Blackwell and Kidwell (1988), Berlin and Loeys (1988), Diamond (1991).

  5. See Sharpe (1990), Diamond (1991) and Rajan (1992) for similar theoretical models. Lummer and McConnell (1989) also provide support for the notion that banks possess idiosyncratic information.

  6. To avoid doubts that the number of banking relationships and percentage of bank debt may be highly correlated so that a multicollinearity problem may exist, we perform a multicollinearity test. The result of the VIF test is 1.21 (less than 10), rejecting the null hypothesis of multicollinearity. This evidence also implies that both variables can be included in the equation simultaneously.

  7. The cash ratio may be measured by another proxy: cash plus marketable securities deflated by sales. The results are qualitatively similar.

  8. Please see Degryse and Ongena (2001), Bhattacharya and Gabriella (1995), Yosha (1995), Detragiache et al. (2000); Bolton and Scharfstein (1996), Von Rheinbaben and Ruckes (1998).

  9. More than 70 % of corporate bank loans are collateralized in Taiwan. See Yu et al. (2012). One of the reasons for the use of collateral might arise from the regime for creditors’ rights. Banks in a market, like Taiwan during our sample, where the creditors’ protection is weak may exhibit a stronger incentive to collateralize their loans. According to data in BankScope, Taiwan has a low creditor’s right of only 2, compared to the other three Asian dragons of Hong Kong with 4, Singapore with 4, and Korea with 3.

  10. Empirical studies establishing the general importance of large shareholders in corporate governance include Demstez and Lehn (1985), Shleifer and Vishny (1986), Morck et al. (1989) and Bertrand and Mullainathan (2001).

  11. Corporate boards in Taiwan are comprised of two parts: a board of directors and another board of supervisors. Directors are responsible for managing the firm, while supervisors are responsible for monitoring the directors. Claessens et al. (2002) find that almost 80 % of firms in Taiwan have managers who belong to the controlling group.

  12. Our Tobin’s Q is calculated as the book value of total assets minus the book value of equity plus the market value of equity divided by the book value of total assets. This Q is different from Asako et al. (1989) who defined Q as the market value of the firm’s net debt and equity as a fraction of the replacement cost of capital stock. Replacement costs are computed using estimated depreciation rates and price indices for each capital stock component. Unfortunately, the TEJ data do not disclose the depreciation method, and so we resort to an alternative specification.

  13. Laporta et al. (2000) support the conjecture that higher shareholder rights are associated with higher dividend payouts.

  14. 9 Bates et al. (2009) also find a similar sign.

  15. Some of this may be in part to the relatively small sample size, but the results are robust to a four, five, six or even seven year split.

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Acknowledgments

We are grateful to Kehluh Wang, H.H. Huang, Yehning Chen, Der-Tzon Hsieh and seminar participants at National Chiao-Tong University and Chung Yuan University for their helpful comments.

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Authors and Affiliations

  1. Department of International Business, Chung Yuan University, Chung-Li, 32023, Taiwan

    Hai-Chin Yu

  2. Department of Finance and Economics, Rutgers University, 94 Rockafeller Rd., Piscataway, NJ, 08854, USA

    Ben J. Sopranzetti & Cheng-Few Lee

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  1. Hai-Chin Yu
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  2. Ben J. Sopranzetti
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Correspondence to Ben J. Sopranzetti.

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Yu, HC., Sopranzetti, B.J. & Lee, CF. The impact of banking relationships, managerial incentives, and board monitoring on corporate cash holdings: an emerging market perspective. Rev Quant Finan Acc 44, 353–378 (2015). https://doi.org/10.1007/s11156-013-0402-8

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