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Agency theories predict that the value of corporate cash holdings is less in countries with poor investor protection because of the greater ability of controlling shareholders to extract private benefits from cash holdings in such countries. Using various specifications of the valuation regressions of Fama and French (1998) , we find that the relation between cash holdings and firm value is much weaker in countries with poor investor protection than in other countries. In further support of the importance of agency theories, the relation between dividends and firm value is weaker in countries with stronger investor protection. Copyright 2006 by The American Finance Association.

for providing us with his data. Pinkowitz and Williamson thank the Capital Markets Research Center at Georgetown University for support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

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lot of public companies today are asking themselves the question, "How much cash do we really need to operate our business, and what's the value to our shareholders of our having another dollar of cash on our balance sheet?"In the fi nancial economist's "frictionless dream world" of perfect capital markets, as Merton Miller was fond of calling it, these questions would be "irrelevant," a matter of indifference to companies and their investors. That is to say, in a tax-free economy where investors were fully informed about a company's earnings prospects, where troubled companies could be reorganized quickly and costlessly, and where managers could always be counted on to make value-maximizing operating and investment decisions, a dollar of cash on the corporate balance sheet would have to be worth a dollar to investors-no more, no less.But in the "real world" of taxes and major information and agency problems, the corporate cash decision can have considerable consequences for corporate values. In an article called "The Paradox of Liquidity," 1 Stewart Myers and Raghuram Rajan described corporate cash holdings as a "double-edged sword." For smaller, riskier companies with limited access to capital markets and promising investment opportunities, cash can serve as a value-preserving buffer against adverse outcomes (including the possibility of Chapter 11) as well as a low-cost means of funding growth opportunities. But there is also a clear downside for investors of excess corporate cash: the well-documented tendency of corporate managers in mature, cash-generating companies to retain excess cash instead of paying it out to shareholders-and then spend it on value-reducing projects such as diversifying acquisitions. 2 Economists refer to the loss in value attributable to such behavior as the "agency costs of free cash fl ow."Faced with these potential corporate uses and misuses of cash, investors should assign a value to a company's cash holdings based on their assessment of how management will eventually use the funds. To investigate this possibility, we recently conducted a study of the liquid assets-that is, cash plus marketable securities-of some 13,000 U.S. companies over a 40-year period (1965-2004) that attempts to determine the value that investors effectively attribute to such assets. 3