Cash Holdings Adjustment Speed and Managerial Ability

• Author: Sera Choi,Mi‐Ok Kim,Hyungjin Cho
• Published date: 01 October 2018
• Date: 01 October 2018
• DOI: http://doi.org/10.1111/ajfs.12235

Cash Holdings Adjustment Speed and

Managerial Ability

Hyungjin Cho

Department of Business Administration, Universidad Carlos III de Madrid, Spain

Sera Choi*

Business School, Seoul National University, Republic of Korea

Mi-Ok Kim

Department of Tax Accounting, Baewha Women’s University, Republic of Korea

Received 20 November 2017; Accepted 12 May 2018

Abstract

Using the partial adjustment model of cash holding, we find that managerial ability is nega-

tively related to adjustment speed of cash holdings toward the target, particularly when the

firm has excess cash. We also find that the relation between managerial ability and cash hold-

ing adjustment speed is weaker in the presence of the internal capital market. Additionally,

we provide evidence that firms with higher managerial ability are less likely to make ineffi-

cient investments when they have excess cash, implying that high-ability managers are willing

to hold a large amount of cash to make timely investments.

Keywords Cash holdings; Internal capital market; Investment efficiency; Managerial ability;

Partial adjustment model

JEL Classification: G32

1. Introduction

In 2013, Carl Icahn purchased Apple Inc.’s stocks and argued that Apple should

utilize its cash holdings by redistributing them to equity investors through divi-

dends and stock repurchases. Similarly, in 2016, Paul Singer, under the name of

Elliott Management, requested Samsung Electronics Co. to increase dividend pay-

ments and future payouts in order to increase shareholders’ wealth. A common

feature in these cases is that they are both successful companies w ith large cash

holdings. Apple and Samsung Electronics are widely known for their iconic man-

agers, Steve Jobs and Kun-Hee Lee, respectively, and shareholders have benefited

from these companies’ strong performance that is a result of their managers’

*Corresponding author: Business School, Seoul National University, 1 Gwanak-ro, Gwanak-

gu, Seoul 08826, Korea. Tel: +82-2-880-6839, Fax: +82-2-878-0101, email: src0422@snu.ac.kr.

Asia-Pacific Journal of Financial Studies (2018) 47, 695–719 doi:10.1111/ajfs.12235

©2018 Korean Securities Association 695

excellent investment and operating decisions. Thus, the managerial ability of these

companies is a good reason to hold larger cash holdings than other less compe-

tent companies. While many prior studies have highlighted the importance of

cash holding management for the survival and growth of modern corporations

(Opler et al., 1999; Bates et al., 2009), they have failed to provide a comprehen-

sive understanding of how managerial ability is associated with cash holding deci-

sions, as shown in these cases.

To shed light on the relation between managerial ability and cash holding deci-

sions, we focus on the adjustment speed of cash holding towards the optimal leve l,

because cash holding dynamics illustrate how specific determinants are related to

trade-offs of cash holding decisions. Opler et al. (1999) document that firms have a

target level of cash holdings and, whenever there is a deviation between the actual

and the target cash holdings, they adjust it towards that target. Dittmar and Duchin

(2011) also estimate that firms close the deviation between actual and target level of

cash holdings by 21–46% in each year. Jiang and Lie (2016) suggest that firms close

31% of the deviation from the target level of cash holdings each year and this speed

is faster when they have larger cash holdings than the target. We link this line of lit-

erature to managerial ability because several studies provide evidence that higher

managerial ability is related to better forecasting ability (Bamber et al., 2010; Baik

et al., 2011), which leads to higher future performance and firm value (Chemmanur

and Paeglis, 2005; Agarwal et al., 2011; Demerjian et al., 2013; Goodman et al.,

2013). Cash holding adjustments require estimating the target level of cash holdings,

detecting the deviation of actual cash holdings from the target, accumulating cash

savings, or spending cash through investments and redistributions. These activitie s

require managers to check the current status of financial positions and forecast

future cash flows. Furthermore, whether the firm spends cash on investments, debt

repayments, or on stock repurchase depends on managerial abilities to capture

growth opportunities and communicate with current and attract potential investors.

When a firm has cash holdings smaller than the optimal level, more able man-

agers of the firm will detect a liquidity problem more easily and preemptively so as

to avoid external financing costs, and they will exhibit a faster upward adjustment

speed of cash holdings towards the target. Also, managers with better ability in

firms having higher cash holdings than the optimal level are more likely to detect a

decreasing marginal value of cash holding and the potential damage of firm value

due to a free cash flow problem, and will then close the gap between the actual and

target level of cash holdings more swiftly. These arguments lead us to predict a pos-

itive relation between managerial ability and cash holding adjustment speeds. How-

ever, small cash holdings would not damage or threaten shareholder wealth for

firms with high-ability managers because those managers would better cope with

low cash holdings by efficient liquidity management and a cooperative relationship

with lenders or suppliers. Also, a higher level of cash holdings relative to the opti-

mal level can be used to make timely investments if more able managers are better

at detecting investment opportunities than less able managers.

H. Cho et al.

696 ©2018 Korean Securities Association