We empirically test the risk-reduction hypothesis of the agency theory in the context of corporate cash holdings. Since corporate cash holdings can be viewed as risk-free investments, the risk-reduction hypothesis predicts that a risk-averse and self-interested CEO allocates more firm assets to corporate cash holdings to reduce firm risk at the expense of giving up some positive NPV but risky projects, which is not beneficial to shareholders. We use the sensitivity of the value of a CEO's stock options to stock return volatility (Executive Stock Options risk incentives) to study the relation between a CEO's risk incentives and corporate cash holdings. We find that firms with lower ESO risk incentives have more corporate cash holdings. We find that more corporate cash holdings reduce firm risk, and that corporate cash holdings have a negative marginal impact on firm value due to the risk-related agency problem. These findings are consistent with the risk-reduction hypothesis of the agency theory in the context of corporate cash holdings. ABSTRACTWe empirically test the risk-reduction hypothesis of the agency theory in the context of corporate cash holdings. Since corporate cash holdings can be viewed as risk-free investments, the risk-reduction hypothesis predicts that a risk-averse and self-interested CEO allocates more firm assets to corporate cash holdings to reduce firm risk at the expense of giving up some positive NPV but risky projects, which is not beneficial to shareholders. We use the sensitivity of the value of a CEO's stock options to stock return volatility (Executive Stock Options risk incentives) to study the relation between a CEO's risk incentives and corporate cash holdings. We find that firms with lower ESO risk incentives have more corporate cash holdings. We find that more corporate cash holdings reduce firm risk, and that corporate cash holdings have a negative marginal impact on firm value due to the risk-related agency problem. These findings are consistent with the risk-reduction hypothesis of the agency theory in the context of corporate cash holdings.
This paper studies the effect of firm diversification on the value of corporate cash holdings. We develop two hypotheses based on efficient internal capital market and agency problems. We find that the value of cash is lower in diversified firms than in single-segment firms, and that firm diversification is associated with a lower value of cash in both financially unconstrained and constrained firms. We find that firm diversification has a negative (zero) impact on the value of cash among firms with a lower (higher) level of corporate governance. These findings are consistent with the interpretation that firm diversification reduces the value of corporate cash holdings through agency problems.
a b s t r a c tThe transaction cost theory of managerial ownership and firm value predicts that deviations from optimal managerial ownership reduce firm value. This paper empirically tests the transaction cost theory by studying the relation between deviations on either side of optimal CEO ownership and firm value. We find that both above-optimal and below-optimal deviations reduce firm value. We find that a change in CEO ownership is associated with a higher (lower) abnormal return if it moves the ownership towards (away from) the optimal level. These findings are consistent with the transaction cost theory of managerial ownership and firm value.
The Split Share Structure Reform in China enables state shareholders of listed firms to trade their restricted shares. This renders the wealth of state shareholders more related to share price movements.We predict this reform will create remuneration arrangements that increase the relationship between Chinese firms' executive pay and stock market performance. We confirm this prediction by showing such effect among state-controlled firms and especially those where dominant shareholders have greater incentives to improve share return performance. Our results indicate this reform strengthens the accountability of executives to external monitoring by stock market and therefore benefit minority shareholders in China.
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