Information asymmetry and the value of cash

This study investigates the market value of corporate cash holdings in connection with firm-specific and time-varying information asymmetry. Analyzing a large international sample, we test two opposing hypotheses. According to the pecking order theory, adverse selection problems make external financ...

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Bibliographic Details
Published in:Journal of banking & finance 2010-09, Vol.34 (9), p.2168-2184
Main Authors: Drobetz, Wolfgang, Grüninger, Matthias C., Hirschvogl, Simone
Format: Article
Language:English
Subjects:
Analysts’ forecasts
Asymmetric information
Asymmetry
Capital market
Cash flow
Cash holdings
Cash holdings Value of cash Information asymmetry Analysts' forecasts
Earnings per share
Financial economics
Financial institutions
Financial systems
Forecasts
Information
Information asymmetry
Market value
Studies
Valuation methods
Value of cash
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Summary:This study investigates the market value of corporate cash holdings in connection with firm-specific and time-varying information asymmetry. Analyzing a large international sample, we test two opposing hypotheses. According to the pecking order theory, adverse selection problems make external financing costly and imply a higher market value of a marginal dollar of cash in states with higher information asymmetry. In contrast, the free cash flow theory predicts that excessive cash holdings bundled with higher information asymmetry generate moral hazard problems and lead to a lower market value of a marginal dollar of cash. We use the dispersion of analysts’ earnings per share forecasts as our main measure of firm-specific and time-varying information asymmetry. Extending the valuation regressions of Fama and French [Fama, E.F., French, K.R., 1998. Taxes, financing decisions, and firm value. Journal of Finance 53, 819–843], our results support the free cash flow theory and indicate that the value of corporate cash holdings is lower in states with a higher degree of information asymmetry.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2010.02.002