Effects of the separation of ownership and control on corporate cash decisions

• Main Author: Couzoff, Panagiotis
• Published: Lancaster University 2015
• Subjects: 338.5
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.724988

This thesis consists of two studies related to the disentangling of moni­toring effectiveness and managerial entrenchment, and the examination of their distinct effect on corporate cash decisions. In the first study, I design a discrete-time model of delegated cash man­agement where effectiveness of monitoring and managerial entrench­ment are explicitly accounted for. The solution supports that both more effective monitoring (stronger governance) and higher manage­rial entrenchment (weaker governance) lead to higher cash holdings. The model also predicts that more effective monitoring has a positive effect on the marginal value of cash, while managerial entrenchment a negative one. I empirically test my predictions on a large sample of US firms. The empirical results confirm my model’s predictions. My findings provide, among others, an explanation as to why aggregate proxies for the quality of corporate governance are unlikely to capture its twofold effect on cash holdings. In the second study, I extend the analysis to a dynamic setup in order to theoretically investigate a wider set of effects. I build a continuous-­time model where refinancing is possible, but costly. Shareholders make active decisions regarding the firm’s refinancing policy (equity issuances), whereas the payout decision remains with the manager. The model implies that the marginal values of cash can be less than one. This result matches empirical findings on the value of cash more closely than standard cash accumulation models. Regarding the effects of monitoring effectiveness and managerial entrenchment on the levels of cash, the results are in line with those of the first study. The model produces a novel result regarding the effects of monitoring effective­ness and managerial entrenchment on the value of cash. That is, the relation between the effectiveness of monitoring and the value of cash is U-shaped indicating that tightening monitoring might in fact result in lower values of cash. Given that the effect of entrenchment on the value of cash is unambiguously negative, the result indicates higher values of cash may be associated with enhanced external corporate control mechanisms, but not necessarily with stricter internal monitor­ing procedures. Although risk management policy largely depends on the respective control rights, my model reveals a substantial range of cash levels in which both parties benefit from risk-reducing operations.