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Governance mechanisms, investment opportunity set and SMEs cash holdings

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Abstract

This study analyses the effect of firm characteristics and governance mechanisms on cash holdings for a sample of UK SMEs. The results show that UK SMEs with greater cash flow volatility and institutional investors hold more cash; whereas levered and dividend paying SMEs with non-executive ownership hold less cash. We also find that ownership structure is significant only in explaining the cash holdings for firms with high growth investment opportunities, and leverage is only significant in explaining the cash held by firms with low growth investment opportunities. Our findings suggest that internal governance mechanisms are more effective for SMEs with high growth investment opportunities, while external governance mechanisms, such as capital market monitoring, are more effective for firms with low growth investment opportunities.

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Notes

  1. A notable exception for the focus on SMEs is the study by Garcia-Teruel and Martinez-Solano (2008) who investigate the effect of firm financial characteristics on cash holdings for a Spanish sample.

  2. According to Von Kalckreuth and Murphy (2005) small and medium firms represent around 54% of the gross value added in the UK economy, 56% of employment and 52% of turnover.

  3. Indeed, Opler et al. (1999) argue that large cash holdings are a potential source of severe agency costs. Subsequent studies support this conjecture. For instance, Harford (1999) shows that firms with large cash reserves are more likely to enter into business activities that destroy firm value. Dittmar and Mahrt-Smith (2007) documented that shareholders place lower value on an additional dollar of cash reserves when agency problems are likely to be greater in the firm.

  4. This definition of corporate cash holdings is consistent with the study carried out by Ozkan and Ozkan (2004).

  5. Hereafter referred to as the Code.

  6. This definition of SMEs is consistent with the UK’s Company Act (2006).

  7. Ozkan and Ozkan (2004) employ a similar methodology to examine the determinants of cash holdings.

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Authors and Affiliations

  1. Middlesex University Business School, Middlesex University, London, NW4 4BT, UK

    Yacine Belghitar & James Khan

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  1. Yacine Belghitar
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  2. James Khan
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Correspondence to Yacine Belghitar.

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Belghitar, Y., Khan, J. Governance mechanisms, investment opportunity set and SMEs cash holdings. Small Bus Econ 40, 59–72 (2013). https://doi.org/10.1007/s11187-011-9366-z

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