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Corporate Governance, Product Market Competition,

Corporate Diversification and Value of Cash Holding.

(A Doctoral Dissertation PhD-Finance)

Faculty of Management Sciences

INTERNATIONAL ISLAMIC UNIVERSITY

ISLAMABAD

Researcher

Idrees Ali Shah

Reg No. 37-FMS/PHDFIN/S11

Supervisor

Dr. Syed Zulfiqar Ali Shah

Associate Professor

International IslamicUniversity

Islamabad

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Corporate Governance, Product Market Competition,

Corporate Diversification and Value of Cash Holding

(A Doctoral Dissertation PhD-Finance)

Idrees Ali Shah

Registration No. 37-FMS/PHDFIN/S11

Submitted in partial fulfillment of the requirements for the

PhD degree with specialization in Finance

at the Faculty of Management Sciences

International Islamic University

Islamabad.

Supervisor ( Febuary, 2018)

Associate Professor

Dr. Syed Zulfiqar Ali Shah

International Islamic University Islamabad

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In the name of Allah, the most merciful and beneficent

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DEDICATION

“To my father Mian Gul Badshah, my mother, my supervisor Dr. Syed

Zulfiqar Ali Shah and to my teachers, for their unconditional love, prayers and

support to make my dreams come true.”

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ABSTRACT

The purpose of this research is to investigate effect of corporate governance on

different facets of cash management i-e, level of cash holding, value of cash holding,

utilization of excess cash and performance. Furthermore, the role of product market

competition is checked in the relationship of corporate governance with different facets of

cash management and to get more detail analysis role of family ownership and Shariah

compliance is also checked. The research also investigated effect of corporate

diversification on value of cash holding in strong governed firms and poorly governed

firms; competitive and concentrated industries; family and non-family firms; Shariah and

non-Shariah compliant firms.

The study used unbalanced panel data of 196 companies from the years 2006 to

2014. All models generally include time dummies and industry fixed effect with standard

error cluster to firm. The result shows that corporate governance has significant negative

effect on corporate cash holding which supports flexibility hypothesis. Moreover, corporate

governance has significant positive effect on value of cash holding and performance of firm

through efficient utilization of excess cash due to corporate governance. The role of product

market competition is explained in the context of substitution and complementary effect

argument. The results generally support complementary effect of product market

competition for corporate governance in all relationship with cash management and

performance except with level of cash holding that support substitution effect. Substitution

effect claim that external market discipline alone is enough mitigate agency problem. On the

other hand, complementary hypothesis claim that external market discipline need efficient

internal governance to mitigate agency problem.

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Family firms have high agency problem compared to non-family firms and corporate

governance leads to proper utilization of excess cash that leads to high value of cash holding

and performance in family firms. The dissertation also investigated effect of corporate

governance on different facets of cash management in Shariah compliant firms and non-

Shariah compliant firms. The result portray that corporate governance has no significant

effect on level of cash holding. The result postulates insignificant effect on value of cash

holding and utilization of excess cash in Shariah compliant firms which support substitution

effect of Shariah compliance for corporate governance. Excess cash under good governance

has same effect on performance in Shariah and non-Shariah compliant firms and the result

does not support agency theory.

The result also indicates that corporate diversification decreases value of cash

holding due to agency problem. However, it increases value of cash holding in good

governed firms compared to poorly governed firms. Similarly, it increases value of cash

holding in competitive industries compared to concentrated industries because external

market discipline mitigate agency problem. On the other hand, corporate diversification

decreases value of cash holding in family firms, while it has significant effect on value of

cash holding in Shariah compliant firms.

Key words: Corporate governance, Cash holding, Value of cash holding, Competition,

Diversification, Family ownership, Shariah compliance, Pakistan.

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COPY RIGHT

© Idrees Ali Shah (2018).All rights reserved. No part of this Thesis may be reproduced without the

permission of the copyright holder.

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DECLARATION

I hereby declare that this thesis, neither as a whole nor as a part thereof, has been copied out from

any source. It is further declared that I have prepared this thesis entirely on the basis of my personal

effort made under the sincere guidance of my supervisor.

No portion of work, presented in this thesis has been submitted in support of any application for any

degree or qualification of this or any other university or institute of learning.

Idrees Ali Shah

PhD (Finance)

Faculty of Management Sciences

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ACKNOWLEDGEMENT

I would like to extend my sincere appreciation and gratitude to all those people and

especially to teachers who directly or indirectly helped me in this dissertation.

I would also like to extend my honest and truthful appreciation and thanks for mother and

my father Mian Gul Badshah for his endless and everlasting support in my study and future career. I

strongly confess that without his support and moral courage I would not be in a position to complete

this degree.

Special thanks are also due to my supervisor, Dr. Syed Zulfiqar Ali Shah for his precious

time, valuable insight and expert guidance. His patience, encouragement and faith in my abilities

have motivated me and allowed me to grow as a researcher. I specially appreciate his friendly and

supporting style of supervision which allowed me to preserve and accomplish my aim despite many

difficulties and challenges, without his guidance and support this would not have been possible.

I am also very thankful to Higher education commission of Pakistan (HEC) for giving me

PhD scholarship and financial support of my PhD degree. With the support of HEC I completed my

PHD and I improved my communication, behaviors, and educational skills.

I am very thankful to my wife and my daughter Meerab Shah and Manha Shah for their

sacrifice. I also pay my special thanks to my colleagues Mr. Nouman, Mr. Salam, Dr. Tazeem Ali

Shah and Mian Rehmanuddin to help me in my theses. I am also thankful to Mr. Naeem Ullah, Dr.

Sheraz Ahmad, Dr. Habib Ahmad, Mr. Shafiq, Mr. Sabee Ullah, Dr. Imran Saeed, Mr. Yaseer

Mahmood and Mr Hazrat Jan for their encouragement to complete this dissertation.

Idrees Ali Shah

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Table of content

ABSTRACT .................................................................................................................................... v

LIST OF TABLES ........................................................................................................................ xiv

Abbreviation .................................................................................................................................. xv

CHAPTER 1 .................................................................................................................................... 1

INTRODUCTION ........................................................................................................................... 1

1.1Background of the study .......................................................................................................... 1

1.2 Gap Identification ................................................................................................................. 17

1.2Problem statement ................................................................................................................. 22

1.4 Objectives of the study ......................................................................................................... 25

1.5 Research Questions .............................................................................................................. 27

1.6 Significance of the Study ...................................................................................................... 28

1.7 Significance in Pakistani context .......................................................................................... 30

1.8 Contextual Contribution ....................................................................................................... 33

1.9 Theoretical contribution ....................................................................................................... 35

1.10 Delimitation of Research .................................................................................................... 37

1.11 Organization of Study ......................................................................................................... 37

CHAPTER 2 .................................................................................................................................. 38

LITERATURE REVIEW ............................................................................................................... 38

2.1 Corporate governance and Cash holding ............................................................................... 38

2.1.1 Corporate governance, Product market competition and cash holding............................. 44

2.1.2 Corporate governance, Family ownership and Corporate cash holding ........................... 45

2.1.3 Corporate governance, Shariah compliance and Cash holding ........................................ 48

2.2 Corporate governance and value of cash holding .................................................................. 49

2.2.1 Corporate governance, Product market competition and Value of cash holding .............. 53

2.2.2 Corporate governance, Family ownership and Value of cash .......................................... 55

2.2.3 Corporate governance, Shariah compliance and Value of cash holding .......................... 56

2.3 Excess cash and Usage ......................................................................................................... 57

2.3.1 Corporate governance and uses of excess cash ............................................................... 58

2.3.2 Corporate governance, Product market competition and Uses of excess cash .................. 61

2.3.3 Corporate governance, Family firms and Uses of excess cash ......................................... 63

2.3.4 Corporate governance, Shariah compliance and Uses of excess cash .............................. 66

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2.4 Excess cash, corporate governance, and Total factor productivity growth.............................. 66

2.4.1 Excess cash, Corporate governance, Product market competition and Total factor

productivity growth ................................................................................................................ 68

2.4.2 Excess cash, Corporate governance, Family ownership, and Total factor productivity

growth.................................................................................................................................... 70

2.4.3 Excess cash, Corporate governance, Shariah compliance, and Total factor productivity

growth.................................................................................................................................... 71

2.5 Corporate governance, Diversification and Value of cash ..................................................... 73

2.5.1 Corporate diversification, product market competition, and value of cash holding .......... 75

2.5.2 Corporate diversification, Family firms and Value of cash holding ................................. 76

2.5.3 Diversification, Shariah compliance, and value of cash holding ..................................... 77

2.6 Theoretical framework ......................................................................................................... 77

CHAPTER 3 .................................................................................................................................. 82

METHODOLOGY ........................................................................................................................ 82

3.1 Population and Sample size .................................................................................................. 82

3.2 Variables of the study ........................................................................................................... 83

3.2.1 Cash Holding ................................................................................................................. 83

3.2.2 Corporate governance measurement ............................................................................ 83

3.2.3 Diversification measurement.......................................................................................... 85

3.2.4 Product market competition ........................................................................................... 86

3.2.5 Control variables ........................................................................................................... 86

3.3 Panel data analysis ............................................................................................................... 88

3.3.1 Static model ................................................................................................................... 88

3.3.2 Dynamic model ............................................................................................................. 89

3.4 Analytical model .................................................................................................................. 90

3.5 Value of Cash holding .......................................................................................................... 91

3.6 Analytical model for spending excess cash ........................................................................... 93

3.7 Analytical model for governance and total factor productivity growth ................................... 94

3.7.1 Total Factor Productivity Growth................................................................................... 94

CHAPTER 4 .................................................................................................................................. 97

RESULT AND DISCUSSION ....................................................................................................... 97

4.1 Effect of corporate governance on Cash holding ................................................................... 97

4.1.1 Corporate governance and Cash holding ...................................................................... 101

4.1.2 Effect of product market competition on the corporate governance and cash holding

relationship .......................................................................................................................... 103

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4.1.3 The effect of concentration on corporate governance and cash holding relationship ...... 105

4.1.4 Effect of corporate governance on cash holding in family and non-family firms ........... 106

4.1.5 The effect of corporate governance on cash holding in Shariah compliant firms ........... 107

4.1.6 Control of Endogeneity ................................................................................................ 108

4.2 Effect of corporate governance on Value of Cash holding ................................................... 113

4.2.1 Determinates of value of cash holding.......................................................................... 117

4.2.2 Corporate governance and value of cash ...................................................................... 118

4.2.3 The effect of corporate governance on value of cash holding in competitive and

concentrated industries ......................................................................................................... 119

4.2.4 The effect of corporate governance on value of cash holding in family and non-family

firms .................................................................................................................................... 121

4.2.5 Effect of corporate governance on value of cash holding in Shariah compliant and non

Shariah compliant firms ....................................................................................................... 123

4.3 Effect of corporate governance and excess cash on industry adjusted capital expenditure .... 124

4.3.1 Effect of excess cash on industry capital expenditure in good governance firms ........... 126

4.3.2 Effect of corporate governance on excess cash and industry adjusted capital expenditure

relationship in competitive and concentrated industries ......................................................... 128


relationship in family and non-family firms .......................................................................... 129


relationship in Shariah compliant and non-Shariah compliant firms ..................................... 130

4.4 Effect of corporate governance on excess cash and dividend relationship ............................ 131

4.4.1 Effect of excess cash with good governance on dividend .............................................. 133

4.4.2 Utilization of excess cash in the form of dividend under good governance in competitive

and concentrated industries ................................................................................................... 134

4.4.3 Utilization of excess cash in the form of dividend under good governance in family and

non-family firms .................................................................................................................. 135

4.4.4 Utilization of excess cash in the form of dividend under good governance in Shariah

compliant and non- Shariah compliant firms ........................................................................ 136

4.4.5 Effect of corporate governance on excess cash and corporate diversification relationship

............................................................................................................................................ 137

4.5 Role of product market competition, family ownership and Shariah compliance on utilization

of excess cash .......................................................................................................................... 143

4.6 Effect of corporate governance on excess cash and firm performance relationship .............. 149

4.6.1 Role of corporate governance on excess cash and total factor productivity growth

relationship .......................................................................................................................... 150

4.6.2 Effect of excess cash with good governance on total factor productivity growth in

competitive industries........................................................................................................... 153

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4.6.3 Effect of excess cash with good governance on total factor productivity growth in family

firms .................................................................................................................................... 154

4.6.4 Effect of excess cash with good corporate governance on total factor productivity growth

in Shariah compliant firms.................................................................................................... 155

4.6.5 Effect of corporate governance on excess cash and industry adjusted ROA relationship155

4.7 Effect of diversification on value of cash holding................................................................ 158

4.7.1 Effect of corporate diversification on value of cash holding in good and poor governance

firms .................................................................................................................................... 162

4.7.2 Effect of corporate diversification on value of cash holding in competitive and

concentrated industries ......................................................................................................... 163

4.7.3 Effect of corporate diversification on firm value in family and non-family firms .......... 164

4.7.4 Effect of diversification on value of cash holding in Shariah compliant firms ............... 165

CHAPTER 5 ................................................................................................................................ 166

CONCLUSION ........................................................................................................................... 166

5.1 Practical Implications ......................................................................................................... 170

5.2 Limitation .......................................................................................................................... 171

5.3 Future direction .................................................................................................................. 172

REFERENCES ............................................................................................................................ 174

Appendix 1 .................................................................................................................................. 194

Appendix2 ................................................................................................................................... 197

Appendix 3 .................................................................................................................................. 199

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LIST OF TABLES

Table 3.1: Sample size ....................................................................................................... 83

Table 3. 2: Corporate Governance Variables ...................................................................... 85

Table 4. 1: Descriptive Statistics ........................................................................................ 98

Table 4.2: Effect of corporate governance on cash holding (Dependent variable: Cash

holding) ........................................................................................................................... 100

Table 4.3: Dynamic panel model GMM effect of corporate governance on cash holding .. 110

Table 4.4: Descriptive Statistics ....................................................................................... 113

Table 4.5: Effect of Corporate Governance on Value of Cash Holding ............................. 115

Table 4.6: Role of corporate governance and utilization of excess cash on industry adjusted

capital expenditure (Dependent variable ⊿Ind-capex) ...................................................... 125

Table 4.7: Role of corporate governance on excess cash and dividend relationship .......... 132

Table 4.8: Role of corporate governance on spending of excess cash in form of

diversification (dependent variable diversification) .......................................................... 138

Table 4.9: Role of competition, family ownership and Shariah on spending of excess cash

........................................................................................................................................ 144

Table 4.10: Role of corporate governance on excess cash and total factor productivity

growth relationship .......................................................................................................... 151

Table 4.11: Role of corporate governance on excess cash and Industry adjusted ROA

relationship ...................................................................................................................... 156

Table 4. 12: Effect of diversification on value of cashholding(dependent: excess return).. 160

Table 4.13: Determinants of cash holding ........................................................................ 195

Table 4.14: Effect of Competition Family ownership and Shariah Compliance on Total

Factor Productivity and operating profit ........................................................................... 197

Table 4.15: Effect of corporate governance on cash holding ............................................. 199

Table 4.16: Effect of corporate governance on cash holding in competitive industries ...... 199

Table 4.17: Effect of corporate governance on cash holding in family firms and Shariah

compliant firms ................................................................................................................ 200

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Abbreviation

Excess: Excess cash

Govindex: Corporate governance index

Gov: Governance dummy

Div: Dividend payment

Diver: Diversification dummy

TFPG: Total factor productivity growth

Comp: Competitive industries

Conc: Concentrated industries

Family: Family firms

Non-Family: Non family firms

Shariah: Shariah compliant firms

N-Shariah: Non Shariah compliant firms

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CHAPTER 1

INTRODUCTION

The first chapter introduces the dissertation and sets an overall context for the study.

It consists of background of the study, research gaps, problem statement, objectives of the

study, research questions, significant of the study, significance of the study in Pakistan

context, contextual contribution, and theoretical contribution.

1.1 Background of the study

Firms hold cash because the cost of internal financing is lower than the cost of

external financing. The pecking order theory suggests that equity financing is the most

expensive source of financing, while internal financing is the cheapest source of financing

(Modugo, 2013).

Keynes (1936) has discussed three motives of cash holding including the transaction

motive, precautionary and speculative motive. The transaction motive suggests that firms

hold cash to support day to day activities, while the precautionary motive shows that firms

hold cash to defend themselves from sudden external shocks. On the other hand, speculative

motive of cash explain that firms hold cash to avail sudden opportunities arising in the

market. Similarly, according to the financial friction argument firms hoard cash either to get

benefit of transactional economies of scale, or for precautionary motive, or to avoid under

investment (Mulligan, 1997; Opler, Pinkowitz, Stulz, & Williamson, 1999; Almeida,

Campello, & Weisbach, 2004).

However, the benefit of maintaining cash should be greater than the cost of hoarding

cash. The financial economics literature that considers the financial decision of corporate

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sector regarding liquidity, suggests that equilibrium is must between benefit of hoarding

cash as reserve for precautionary purpose and cost of hoarding cash particularly the agency

cost (Jain, Li, & Shao, 2013). Cash is prone to the agency problems since it can easily be

expropriated by entrenched managers and controlling shareholders for their personal benefit

on the cost of shareholders (Harford, Mansi, & Maxwell, 2008). Therefore, proper corporate

governance is needed to reduce agency problem and align interest of managers to the

interest of shareholders.

The cash holding pattern of the corporate sector is changing throughout the world. The

cash holding of US corporate sector has increased from 5% in 1990 to 13% in 2003 (Dittmar

& Mahrt-Smith, 2007). Harford et al. (2008); Jain et al. (2013) also shows that US firms

cash holding increases over time. USA public firms on average hold 18% in form of cash

and marketable securities (Gao, Harford, & Li, 2013). Hussain (2014) claimed that

corporate cash holding in Pakistan too has increased in the last decade due to high earning

of corporate sector. The managers mostly increase corporate cash holding in the wake of

increasing the viability of their firms. This is because in the crises period firms with

sufficient internal funds are more viable compared to the firms with insufficient funds

(Opler et al., 1999). Therefore, cash has gained more importance after the US Subprime

Mortgage crises (2007/2008).

There is now wide detection, as well as growing empirical evidence that corporate

governance arrangements can considerably affect shareholders wealth and corporate

decisions especially cash holding. Corporate governance is “the system through which

companies are directed and controlled" (Cadbury Committee, 1992). Under this system the

corporate objectives of the firms are set, which are then directed, monitored and achieved

with the help of corporate governance.

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Cash is type of asset which is easily expropriated compare to other type of assets

therefore; shareholders have a higher concern for cash compared to other assets. Since,

corporate governance allow outside investors to defend themselves from expropriation of

inside managers and controlling shareholders. Therefore, many studies including Dittmar,

Mahrt-Smith, and Serveas (2003); Pinkowitz and Williamson, (2004); Dittmar and Mahrt-

Smith (2007); Harford et al. (2008) indicate that the problem of under investment reduces

significantly in the presence of good governance and shareholders become less concerned

about the expropriation of cash reserves by mangers for their personal benefits.

The extant research provides insight into the different facets of the firms’ cash holding

and signifies the role of corporate governance in determining their cash holding decisions.

This dissertation adds to the extant literature by investigating the effect of corporate

governance on different facets of corporate cash holding in the context of Pakistan. There

are five important aspects of our study, which differentiate it from the previous

researches:

The first aspect of our study is to investigate the relationship between corporate

governance and cash holding, and to investigate the role of product market competition,

family ownership, and Shariah compliance in the relationship of corporate governance and

cash holding. Cash holding and corporate governance have gained significant importance in

the corporate finance literature.

Harford et al. (2008) concludes three hypotheses on effect of corporate governance and

cash holding including the flexibility hypothesis, spending hypothesis and shareholder

power hypothesis. According to flexibility hypothesis corporate governance is negatively

related to cash holding because due to agency problem managers hold cash to defend them

from external capital market discipline (Jensen, 1986). On the other hand, the spending

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hypothesis claims that mangers disgorge cash on value reducing investments due to agency

problem. Therefore, agency problem is negatively related to corporate cash holding.

Shareholder power hypothesis on the contrary claims that shareholders trust managers and

allow them to hold cash to avoid under investment problem when agency problem is low.

The empirical researches on corporate governance and level of cash holding report

mixed results. For example, Harford et al. (2008) found positive relationship between

corporate governance and cash holding and shows that firms with good governance hold

more cash as compared to firms with poor governance. In contrast, Dittmar et al. (2003)

found negative relationship between corporate governance and cash holding using

international data. On the other hand, Kalcheva and Lins (2007) showed insignificant

relationship of corporate governance and cash holding. These divergent findings suggest

that the effect of corporate governance on the cash holding may be different across different

industries and ownership structures. To answer the question this study investigates the effect

of corporate governance on cash holding in competitive industries, family owned firms and

Shariah compliant firms.

The concept of product market competition and its effect on corporate decision is

deeply discussed in economics literature. Finance researchers have also discussed the effect

of degree and nature of competition in product market on cash flows of firm, investment and

choices of firm finances (e.g. Haushalter, Kalsa, & Maxwell, 2007; Xu, 2012; Hou &

Robinson 2006; Hoberg & Phillips, 2010). The role of product market competition in the

corporate governance and level of cash holding relationship is explained on the basis of two

arguments including the substitution effect argument and the complementary effect

argument. According to substitution effect argument competition works as external market

discipline to mitigate agency problem between managers and owners even firm level

governance is poor. Therefore, corporate governance do has low significance in competitive

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industries compared to the concentrated industries. In contrast, complementary hypothesis

shows that competition alone is insufficient to mitigate agency problems and need efficient

governance to mitigate the agency problem arising between shareholders and mangers.

Therefore, efficient governance is needed with external market discipline to mitigate agency

problems.

On the basis of theoretical model Hermalin (1992) argued that the bargaining power

of stockholders decreases agency problem and agents of the firms become sensitive to

competition in product market. Furthermore, he concluded that corporate governance is

complemented by competition. Padilla (2000); Januszewski, Koke, and Winter (2002);

Grosfeld and Tressel (2002) suggests that competition needs efficient corporate governance

to mitigate agency problem and corporate governance is complemented by competition. On

the other hand, the researchers like Holmstrom (1982); Nalebuff and Stiglitz (1983); Hart

(1983); Giroud and Mueller (2010, 2011); Guadalupe and Perez-Gonzalez (2010) found that

competition is a substitute for corporate governance and governance matters more in

concentrated industries than the competitive industries.

Another insight of this research is whether corporate governance has different effect

on corporate cash holding in family and non-family firms. Family ownership is an important

type of ownership in Pakistan and all over the world. Family ownership is increasing in

Pakistan in a sizable manner particularly in the unlisted firms. Family firms plays important

role in the promoting economy (La Porta, Lopez-DE-Silances, & Shilfer, 1999; Claessens,

Djankov, & Lang, 2006; Faccio & Lang, 2002; Anderson & Reeb, 2003a). Research on

corporate governance in family firms has got attention in the recent era especially on the

family firms’ control right in the perspective of corporate governance (Wei, Wu, Len, &

Chen, 2011). Family firms resolve classic agency problem between managers and

shareholders due to the concentration in the hands of family members. Family members

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want long run survival of the firm and actively monitor the activities of managers (Wei et

al., 2011; Villalonga, Amit, Trujillo, & Guzman, 2015). The mitigation of agency problem

between managers and shareholders due to ownership concentration become beneficial for

all shareholders. On, the other hand agency conflict between controlling shareholders and

minority shareholders are higher in family firms (Villalonga et al., 2015). Moreover, family

firms engage in family altruism and want to pass business to their successors and

expropriate cash to fulfill firm legacy (Kuan, Li, & Chu, 2011). So, corporate governance is

more important in family firms to monitor the activities of controlling shareholders.

Another type of firm structure gaining importance globally and Pakistan is not

exception is Shariah compliant firms. A firm has to pass certain screening criteria (i.e.,

Qualitative and Quantitative criterion) for inclusion in the Shariah compliant firms.

Qualitative criterion requires that core business nature should not be against Shariah e.g.

wine business, pork business, casino business etc. On the other hand, the quantitative

criteria include some financial ratio that should meet certain criteria set by Shariah

committee. For example, debt to asset ratio should be less than 37%, non-compliant

investments to asset ratio should be less than 33%, illiquid assets to total asset ratio should

be at least 25%, and non-compliance revenue to total revenue ratio should be less than 5%.

(“Shariah Methodology,”n.d.).

The extant literature suggests that Shariah compliant firms have low debt compared

to the non- Shariah firms. Since, low debt is substitute to corporate governance therefore;

Shariah compliance is a substitute to good governance due to low debt and other financial

criteria. Debt is used as external monitoring for managers and reduce agency problem

(Jensen 1986; Stulz 1990; Zwiebel, 1996). Firms with poor corporate governance have high

debt to mitigate agency problem and constraint mangers to waste the resources of firm

(Jiraporn, Kim, Kim, & Kitsabunnarat, 2012; Ullah & Rizwan, 2018). As, per agency theory

7

explanation firms with good governance don’t need high debt to mitigate agency problem.

Low levered companies are good governed and Shariah compliant firms have low debt

compared to non-Shariah compliant firms. Therefore, Shariah compliant firms have good

governance compare to its counterpart (Hayat & Hassan, 2017). Therefore, Shariah

compliant firms do not need high debt to control agency problem. Furthermore, Ullah and

Rizwan (2018) found that Shariah compliant firms work as alternative for corporate

governance. This shows that Shariah compliant firms have substitution effect on corporate

governance and cash holding relationship. Moreover, Shariah compliant firms have

advantage over non- Shariah compliant firms on the basis of tax reduction due to interest.

To avoid interest base financing Pakistan gives 2% tax rebate to Shariah compliant firms to

promote Shariah compliance (Shaikh, 2016).

The second aspect of our study is that whether corporate governance effects value of

cash holding. Moreover, the role of product market competition, family ownership, and

Shariah compliance in the relationship of corporate governance and value of cash holding is

investigated. The expropriation behavior of mangers and controlling shareholders destroy

firm value due to agency problem. Therefore, corporate governance improves firm value

through efficient utilization of excess cash. Good governance reduces agency problem and

increase firm value due to positive effect of good governance on stock prices and investor

perception. Moreover, in the presence of good governance, managers are unable to divert

firm cash flow to un-profitable project and board of directors willingly distributes cash in

form of dividend to existing shareholders and increase value of firm (Jensen & Meckling,

1976; La Porta et al., 2002). Similarly, good governance reduces cost of capital due to

reduction of supervision and auditing cost (Shleifer & Vishny, 1997).

The existence of agency problem and conflict between principal and agent

relationship destroy value of firm (Ditmar & Mahrt-Smith, 2007; Pinkowitz, Stulz, &

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Williamson, 2006; Kalcheva & Lins, 2007; Jain et al., 2013). The previous studies show that

corporate governance positively affects value of firm due to efficient utilization of cash

(Yermack, 1996; Gompers, Ishii, & Metrick, 2003; Cremers & Nair, 2005; Core, Guay, &

Rusticus, 2006; Bebchuck, Cohen, & Farerell, 2009). However, few researchers are of the

view that it is inconclusive whether execution of proper governance affects firm value

because governance bears some cost that may outweigh the advantage of corporate

governance (e.g., Gillan & Starks, 2003; Chhaochharia & Grinstein, 2007; Bruno &

Claessens, 2010).

The empirical literature that shows effect of corporate governance on firm value,

dominantly measured firm value through Tobin Q (like Yermack, 1996; Kalcheva & Lins,

2007; Amman, Oesch, & Schmid, 2013). Tobin Q basically measures value of firm on basis

of total assets. However, according to Dittmar and Mahrt-Smith (2007) valuation of cash is

important instead of other type of assets to find out value effect of corporate governance.

The reason is that cash is easily expropriated by managers for their personal interest

compare to other types of assets and therefore, cash has very important position in overall

value of firm. Their study further point out that variation in cash is higher than the variation

in firm level governance. Therefore, powerful test is demanded to find out effect of

corporate governance on value of cash holding and uses of excess cash. Similarly, Dittmar

and Mahrt-Smith (2007) further shows that value of excess cash is almost twice in good

governance firms compared to poor governance firms due to efficient utilization of excess

cash in good governance firms. Keeping in view these suggestions the present study

investigates the effect of corporate governance on value of cash holding following the model

of Faulkender and Wang (2006). Their model uses change in cash for calculating firm value

instead of Tobin Q.

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The present study also investigates whether effect of corporate governance on value

of cash holding vary across different industries and ownership structures. Therefore, the

relationship of corporate governance and value of cash holding is tested in competitive and

concentrated industries, family and non-family firms, and Shariah compliant and non-


The extant literature shows that competition works as a market discipline that

mitigates agency problem (Amman et al., 2013). Product market competition forces

managers to work in the best interest of shareholders (Alimov, 2014). According to

substitution effect corporate governance has insignificant effect on value of cash holding in

competitive industries compared to the concentrated industries. Product market competition

works as external market discipline that mitigate agency problem despite of firm poor level

governance and increase value of cash holding. Amman et al. (2011) found that corporate

governance has significant effect on firm value only in concentrated industries and their

result support substitution effect. Their study used proxy of total firm value measured

through Tobin Q instead of excess return. On the other hand complementary effect argument

suggest that corporate governance has significant effect on value of cash holding in

competitive industries because external market discipline needs efficient governance to

mitigate agency problem. Jain et al. (2013) shows that corporate governance has significant

effect on value of cash holding in competitive industries compare to concentrated industries

and shows complementary effect of product market competition for corporate governance in

relationship with value of cash holding.

Similarly, family ownership is also an important to consider because the corporate

sector of Pakistan is characterized by family ownership. Moreover, family firms have

significantly different structure compared to non-family firms. Therefore, the present study

also investigates the effect of corporate governance on value of cash holding in family and

10

non-family firms. Family ownership mitigates the conflicts between managers and

shareholders through keen supervision of the activities of managers.

However, the agency problem between controlling family shareholders and minority

shareholders is high in family firms (Shliefer & Vishney, 1997; Villalonga & Amit, 2006).

Thus the overall value of firm decreases due to conflict between controlling shareholders

and minority shareholders. Family firms face difficulty in raising funds through minority

shareholders, if the cost of minority shareholders conflict with majority family shareholders

is higher than the conflict between managers and shareholders (Puerto, 2010).

Family firms usually involve in the policies that benefit a particular family and

destroy overall firm value (Smith & Amoaka-Adu, 1999; Perez-Gonzalez, 2006; Bennedsen,

Nielsen, Perez-Gonzalez, & Wolfenzen, 2007). Previous studies recognize that the

appointment of a family successor as CEO or Chairman of a firm destroys performance and

value of firm. The reason is that families successors tend to miss-utilize the power of

corporate control for their own benefit (Volpin, 2002; Holderness, 2003; Enriques &

Volpin, 2007). This study contributes to existing literature by empirically examining the

effect of corporate governance on value of cash holding in family and non-family firms.

Recently, Shariah compliance has gained attention as the determinant of firm value

(Lusyana & Sherif, 2017). Value of cash holding is reduced due to agency problem because

excess cash is miss-utilized due to agency problem (Jain et al., 2013). Corporate governance

reduce agency problem and increase value of cash holding (Dittmar & Mahrt-Smith, 2007)

and Shariah compliance also plays the same role. Shariah compliant firms have different

structure from non-Shariah compliant firms (Amina, 2015). Shariah compliant firms follow

the principles of Shariah which is alternate to good governance. The effect of corporate

governance on firm value in Shariah compliant firms is ignored in the extant literature

11

though it is an important determinant of firm value. Therefore, the present study investigates

the effect of corporate governance on firm value in Shariah compliant and non-Shariah

compliant firms. The essence of modern corporate governance is to protect outsider

investors from insiders i.e., managers and controlling shareholders. Similarly, Islam does

not allow a person to get benefit on the expense of others and discourages the destruction of

the others’ wealth for personal benefit. Therefore, Shariah compliance is alternate to

corporate governance. Moreover, Shariah compliant firms have low interest bearing debts

compared to the non-Shariah compliant firms. Jensen (1986) claimed that low debt is

substitute to good governance. So, according to substitution effect argument Shariah

compliant firms have low agency problems and substitute for corporate governance.

Consequently, good governance has insignificant effect on value of cash holding as compare

to non-Shariah compliance firms.

The third aspect of our study is to investigate utilization of excess cash in the

presence of strong corporate governance. Furthermore, the study also investigated the role

of corporate governance on utilization of cash in competitive industries, family firms, and

Shariah compliant firms. Firm value is affected due to spending of excess cash i.e., if excess

cash is wasted in hands of managers and controlling shareholders the overall value of firm

decreases and vice versa. Extant research suggests that excess cash is wasted on value

destroying investments by mangers and controlling shareholders due to agency problems

and ultimately lower the economic performance of the firm and value of the firm (Dittmar &

Mahrt-Smith, 2007; Harford et al., 2008; Jain et al., 2013; Bena, Ferreira, Matos, & Pires,

2017).

Keeping in view these findings this dissertation investigates the effect of corporate

governance on spending of excess cash. This research considers three ways of spending

excess cash including capital expenditure, dividend payments, and diversification. Harford

12

et al. (2008); Jain et al. (2013) found that good governance reduce excess cash spending in

form of internal investment (measured through industry adjusted capital expenditure).

According to spending hypothesis managers and controlling shareholders disgorge excess

cash in the form of internal investment due to agency problems (Harford et al., 2008).

Corporate governance mitigates agency problem and restrains insiders from disgorging

excess cash on internal investments.

Second channel of disgorging cash is on dividend which is explained on the basis of

agency theory. Dividend payment reduces free cash flow in the hands of entrenched

mangers. Therefore, mangers are unable to spend excess cash for their own interest because

excess cash is distributed to the shareholders (Jensen & Meckling, 1976; Jensen, 1986). The

substitution model and outcome model provides two possible explanations for effect of

corporate governance and dividend. According to substitution model dividend is substitute

to corporate governance and posits negative relationship with corporate governance (Amina,

2015). On the other hand, outcome model suggest that whenever corporate governance is

good minority shareholders force management to distribute excess cash among shareholders

in form of dividend. Therefore, corporate governance and dividend shows positive

relationship on basis of outcome model (Amina, 2015).

The third way of disgorging excess cash is on corporate diversification. Research

shows that due to agency problem and empire building hypothesis, firms involve in

diversification and particularly the unrelated diversification which destroys overall value of

firm. The recent scandal in India is an example of such diversification where the chairman

of reputed company of United Breweries involved in diversification and started an airline

with brand name of King Fishers which resulted in the destruction of the firm value.

13

This dissertation also investigates whether the role of corporate governance on

spending of excess cash is same for all industries and ownership structures. To answer this

question the research investigated effect of corporate governance on spending of excess cash

in competitive and concentrated industries, family and non-family firms, and Shariah

compliant and non-Shariah compliant firms. Two approaches theoretically support the role

of governance on spending of excess cash in competitive and concentrated industries i.e.,

the substitution and complementary effect. According to substitution effect good governance

has no significant role in the utilization of excess cash in competitive industries as compared

to concentrated industries (Jain et al., 2013). On the other hand, the complementary

argument suggests that external market discipline needs good governance for efficient

utilization of excess cash in competitive industries (Amman et al., 2011). Research shows

that dividend as signal for good governance and firms with poor governance mitigate agency

problem through distribution of excess cash in form of dividend. Therefore, dividend is

comparatively higher in concentrated industries..

Similarly, Family firms also have divergent investment, dividend and diversification

behavior compared to non-family firms. In family firms the controlling shareholders of

particular family tree spend excess cash for their own interest and for the interest of

particular family members on the cost of minority shareholders (Kalcheva & Lins, 2007).

Therefore, to control agency problems between controlling shareholders and minority

shareholders proper governance is needed. Due to agency problems, family firms involve in

empire building and spend excess cash for creating a empire for themselves and for their

successors that ultimately destroy value of firm (Kuan et al., 2011). Good corporate

governance protects minority shareholders from expropriation of controlling shareholders in

family firms. Similarly, Shariah compliant firms have different financial strategies

compared to non-Shariah compliant firms. However, the role of corporate governance on

14

spending of excess cash in Shariah compliant firm is ignored in literature. As discussed

earlier Shariah compliant firms have low agency problems and are alternate to corporate

governance. Moreover, Shariah compliant firms have lower tendency to involve in value

reducing investments due to their structure. Therefore, according to substitution effect

argument good governance has insignificant effect on spending of excess cash in Shariah

compliant firms compared to non-Shariah compliant firms.

The fourth aspect of our study is to investigate the relationship between corporate

governance and firm performance, and to investigate the role of product market competition,

family ownership, and Shariah compliance in the relationship of corporate governance and

firm performance. Corporate governance increase performance of firms due to efficient

utilization of excess cash (Dittmar & Mahrt-Smith, 2007). Previous researches show that

excess cash under good governance increases operating profit of the company and vice versa

(like Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et al., 2013). The negative

effect of excess cash under poor governance on performance indicates that inefficient

spending of excess cash ultimately destroys value of firm.

In this research we adopted total factor productivity growth as a proxy for firm

performance instead of traditional accounting ratios. Productivity growth considers

maximum growth in vector of outputs with the same vector of inputs. Total factor

productivity growth considers the difference of both efficiency change and technology

change, while conventional method does not consider change in technology (Nishimizu &

Page, 1982). Total factor productivity is more appropriate approach to investigate the

performance instead of using accounting ratio alone because ratio may be manipulated by

managers (Tian & Twite, 2011; Barth, Gulbrandsen, & Schone., 2005). In this research we

used total factor productivity growth instead of total factor productivity because the

15

relationship of corporate governance and total factor productivity is prone to endogeneity

problem (koke, 2001).

Proper corporate governance forces managers to utilize resources efficiently which

positively affects performance of the company (Selarka, 2014). Therefore, previous studies

indicate that excess cash has positive effect on total factor productivity growth under good

governance and vice versa.

We have also considered the effect of corporate governance on firm performance

across different industries and ownership structures including competitive and concentrated

industries, family and non-family firms, and Shariah compliant and non-Shariah compliant

firms.

The fifth aspect of our study is to investigate the relationship between diversification

and value of cash holding, and the role of product market competition, family ownership,

and Shariah compliance in this relationship. Among the three forms of spending of excess

cash (i.e., capital expenditure, diversification, and dividend), diversification is the most

dominant source in Pakistan. Due to existence of family firms in Pakistan most of the firms

involve in corporate diversification for empire building for their family members. Therefore,

the present study is curious to investigate direct effect of corporate diversification on firm

value in the context of Pakistan.

Agency cost is involved when a firm involves in diversification. Under the lack of

proper governance mangers involve in diversification that benefit them instead of

shareholders due to agency problem. Mangers get benefit from diversification in several

ways. First, the un-diversifiable employment risk of manger minimizes due to

diversification (Amihud & Lev, 1981). Second, corporate diversification increases the size

of the firm, which leads to the increase in the control of managers (Jensen, 1986). Third,

16

corporate diversification makes manager of firm indispensable (Shliefer & Vishney, 1989).

Keeping in view these benefits managers of firm involve in diversification though it can cost

shareholders and destroy value of firm.

Economists have extensively discussed corporate diversification and its effect on

value of firm. Lang and Stulz (1994); Berger and Ofek (1995) argue that diversification

reduces value of firm due to agency problem. Similarly, Denis, Denis, and Sarin (1997) also

found that corporate diversification reduces overall value of firm due to agency problem

between managers and owners. Moreover, corporate diversification also involved cross-

subsidizing in which managers allocate funds to low growth opportunity projects from high

growth opportunity projects which destroy overall value of firm (Shin & Stulz, 1998; Rajan,

Sarveas, & Zingales, 2000). These results are in line with Jensen (1986) who argues that

managers involve in diversification for their personal benefits.

Diversified firms have severe agency problem compared to stand alone firms (Rajan

et al., 2000). Therefore, proper corporate governance is needed in diversified firm to

increase the value of firm. Diversification increases value of cash holding in good governed

firms (Tong, 2011) and vice versa. However, a very limited literature is available on the

effect of corporate diversification on value of cash holding. The previous researches that are

conducted on effect of diversification on firm value, measured firm value through Tobin Q

(e.g., Lins & Serveas. 2002). This research measures firm value through change in cash

following Faulkender and Wang (2006) and Dittmar & Mahrt-Smith (2007).

This study also investigated effect of corporate diversification on value of cash

holding in family firms. Family firms due to agency problem involve in empire building and

goes towards diversification (Jensen, 1986). Moreover, in emerging economies corporate

diversification discount firm value due to agency problem and low investor protection (Lins

17

& Servaes, 2002). Agency cost is the main cost involved in family firms when they go

towards diversification for their own benefit and destroys overall value of firm. Family

controlled firms involve in diversification to create empire for their successors on the cost of

minority shareholders. Consequently, diversification decreases value of cash holding in

family firms.

Finally, this research investigates whether diversification has significant effect on the

value of cash holding in Shariah compliant firms because Shariah compliance is an

alternative to corporate governance due to the underlying structure of the firms. Moreover,

Shariah compliant firms are constrained to diversify in sectors which are prohibited in

Islam.

1.2 Gap Identification

Firm level of cash holding has got attention from both practitioners and

academicians in the recent era. The probes are concentrated around the linkage between

corporate governance and different facets of cash holding. However, the extant literature is

limited in several ways:

First, the relationship of corporate governance and level of cash holding and value of

cash holding is considered in developed economies (e.g., Harford et al., 2008; Dittmar &

Mahrt-Smith, 2007; Pinkowitz et al., 2006; Kalcheva and Lins, 2007; Kuan et al., 2011; Al-

Najjar & Clark, 2017; Seifert & Gonenc, 2018; Liu & Yuan, 2018). Harford et al. (2008)

suggests that future research should be conducted on relationship of corporate governance

and cash holding in other economies where corporate governance structure and situation is

different. Liu and Yuan (2018) conducted research on U.S non-financial market and found

that corporate governance effect cash holding in financial constraint firms. The future

direction they recommended that effect of corporate governance on cash holding is

18

investigated in other settings beside financial constraints (e.g., product market competition,

Family firms, and Shariah compliance). Similarly, Kuan et al. (2011) provides future

direction to conduct research in countries where family structure and setting of corporate

governance is different. On the other hand, Kalcheva and Lins (2007) recommended that

future research should be conducted on other related factors in addition of agency problem

(e.g., product market competition and Shariah compliance).

Keeping in view these recommendations, this dissertation seeks answer to the

unanswered question i.e., whether effect of corporate governance on cash holding and value

of cash holding vary across different industries and ownership structures. It includes

competitive and concentrated industries, family and non-family firms, and Shariah

compliant and non-Shariah compliant firms in a developing country i.e., Pakistan. Product

market competition acts as an external market discipline to mitigate agency problem and

need to check that whether product market competition has substitution effect or

complementary effect for corporate governance in Pakistan. Because, competition is

comparatively lower in Pakistani industries compared to developed economies because a

limited number of non-financial companies are registered on Pakistan stock exchange.

However, the effect of corporate governance on level of cash holding and value of cash

holding in competitive and concentrated industries is ignored in developing countries

particularly Pakistan, while very limited literature is available in developed countries (e.g.

Jain et al., 2013; Amman et al., 2013).

Similarly, the effect of corporate governance on cash holding in family firms is

investigated in developed economies (e.g. Kuan et al., 2011). In the same way, liu, Luo and

Tian (2015) investigated effect of family control on cash holding but does not consider

direct effect of corporate governance on cash holding in family and non-family firms.

However, the effect of corporate governance on value of cash holding in family firms is

19

ignored in extent literature particularly in the context of Pakistan. The agency problems of

family firms are quietly different as compared to non-family firms because in family firms

the conflict of controlling shareholders and minority shareholders is high compared to the

conflict between mangers and shareholders.

Moreover, Shariah compliant firms have low agency problems compared to non-

Shariah compliant firms and theoretically Shariah compliant firms act as substitute for

corporate governance. Shariah compliant firms portray an important sector in Pakistan.

Pakistan gives 2% tax rebate to Shariah compliant firms to avoid interest based financing

and promote Shariah compliance (Sheikh, 2016). However, the effect of corporate

governance on level of cash holding and value of cash holding in Shariah compliant firms is

ignored in the literature. Guizani (2017) recommended that due to difference of

characteristics between Shariah and non-Shariah compliant firms, future research should

conduct on the effect of corporate governance on cash holding in Shariah compliant firms.

Hayat and Hassan (2017) investigated whether corporate governance differ in Shariah and

non-Shariah compliant firms but they did not investigate the effect of corporate governance

on cash holding and value of cash holding in Shariah and non-Shariah compliant firms.

Second, Masood and Shah (2014) conducted research on corporate governance and

cash holding in Pakistan but they did not use corporate governance index. Moreover, they

recommend that besides agency problem other aspects should also be investigated.

Therefore, the present study uses corporate governance index as a proxy for corporate

governance. Moreover, as discussed earlier three new aspects including competition,

Shariah compliance, and family ownership are also considered in the relationship of

corporate governance and cash holding.

20

Third, the literature on effect of corporate governance on value of cash holding is

very limited. Moreover, the research efforts are concentrated in developed countries (e.g.

Dittmar & Mahrt-Smith, 2007; Jain et al., 2013; Uddin, 2016; Liu & Yuan, 2018). The

future direction recommended by (Liu & Yuan, 2018) is that other factors are considered

besides corporate governance and financial constraints, while determining marginal value of

cash holding. This study considers external market discipline, family ownership and Shariah

compliance, while investigating the effect of corporate governance on marginal value of

cash holding. However, in Pakistan the effect of corporate governance on firm value through

cash i.e., value of cash holding is an academic covert. Similarly, the previous researches on

effect of corporate governance and firm value used Tobin Q for firm value (e.g. Kalcheva &

Lins, 2007; Amman et al., 2011; Ararat, Black, & Yortoglu, 2017). However, the firm value

through the concept of value of cash holding (as suggested by Faulkender & Wang, 2006) is

a better approach than the Tobin Q because cash is easily expropriated by insiders as

compare to other type of assets for their personal benefits. Therefore, the present research

used the concept of value of cash holding (following the work of Faulkender & Wang,

2006) that is change in firm value through cash.

Fourth, corporate governance increases value of firm through efficient utilization of

excess cash. However, the research efforts in this regard are limited. Though, limited

research has been conducted on effect of corporate governance on utilization of excess cash

in U.S.A or using international data (e.g. Harford et al., 2008; Amman et al., 2011; Jain et

al., 2013). However, the effect of corporate governance on utilization of excess cash in

Pakistan is relatively overlooked. Similarly, the role of corporate governance on spending of

excess cash in competitive and concentrated industries, family and non-family firms and

Shariah and non-Shariah compliant firms is also ignored in extent literature.

21

Fifth, excess cash under good governance increases future performance of the

company that is characterized by efficient utilization of excess cash. Zabri, Ahmad and Wah

(2016) investigated effect of corporate governance on firm performance and future direction

of their study is that external mechanism is used to find out effect on firm performance. This

study fills the gap and used both internal governance and external market discipline and

investigated its effect on firm performance. However, there is limited research available in

developed economies that investigated relationship of excess cash under good governance

with the performance of a company (e.g., Dittmar & Mahrt-Smith, 2007; Harford et al.,

2008; Jain et al., 2013). The previous researches used operating profit as a proxy of firm

performance. This dissertation took the proxy of total factor productivity growth instead of

operating profit because operating profit can be manipulated by firm (Tian & Twite, 2011).

Total factor productivity growth shows the relation of outputs and inputs of firm is more

appropriate approach instead of single operating ratio. However, the effect of corporate

governance on excess cash and total factor productivity growth relationship is ignored in

extent finance literature. Moreover, previous researches is also silent about effect of

corporate governance on excess cash and total factor productivity growth relationship in

competitive and concentrated industries, family and non-family owned firms, Shariah and


Finally, corporate diversification is important way of disgorging excess cash as

compared to other ways of disgorging excess cash in Pakistan. The research on effect of

corporate diversification on value of cash holding in good governance firms and poor

governance firms is conducted in developed country (e.g. Tong, 2011). However, the effect

of corporate diversification on value of cash holding is ignored in Pakistan. Espinosa, Jara

Maquieira, and Vieto (2018) conducted research on the relationship of diversification and

firm value and they suggested that in future, research should conduct on the channels

22

through which diversification effect on firm value. This study fill the gap to investigate

effect of corporate diversification on value of cash holding in good governed firm and poor

governed firm, competitive and concentrated industries, family and non-family firms,

Shariah and non-Shariah compliant firms. Tong (2011) investigated the relationship of

diversification and value of cash holding in good governance firms and low governance

firms. However, he did not consider product market competition, family ownership, and

Shariah compliance.

1.2 Problem statement

Cash is the asset which can easily be used by managers and controlling shareholders

for their personal interest and ultimately reduces value of firm. Therefore, proper

governance is needed to stop managers from expropriation. This dissertation empirically

investigates the effect of corporate governance on level of cash holding and value of cash

holding in Pakistan. In Pakistan, the level of corporate cash has increased due to high

earning of companies. In FY 2014-15, blue chips companies in Pakistan had earned

PKR286 billion in terms of cumulative profit after tax (Hussain, 2014). Due to lack of

proper governance this excessive cash is expected to be destroyed by mangers.

Forbes companies in the developed countries cutoff dividend and exercise institution

layoff in the wake of improving their operating statements and internal liquidity. However,

they consequently end up with large reserves of cash but limited investment opportunities.

“Cash creates problems because holding excessive cash is often just as bad as holding

excessive debt” (Picard, 2011). World third giant companies are holding $2.8 trillion cash in

gross terms and worry how to invest this extra cash.

Previous studies have witnessed mixed results for relationship of corporate

governance and cash holding. Harford et al. (1999) found insignificant effect on cash

23

holding. Dittmar et al. (2003); Kusnadi (2011); Amman et al. (2013); Liu and Yuan (2018)

investigated effect of corporate governance on cash holding and found negative relationship

of corporate governance and cash holding. On the other hand, Harford et al. (2008) found

positive effect of corporate governance on cash holding. “The inconclusive result of

corporate governance and cash holding raise question that whether the effect of corporate

governance on level of cash holding and value of cash holding vary across different

industries and ownership structures.” Therefore, dissertation investigates the effect of

corporate governance on cash holding and value of cash holding in variant contexts

including competitive industries, family firms, and Shariah compliant firms.

. Product market competition may have two effects for corporate governance

including the substitution and complementary effect in relationship with cash holding and

value of cash holding. The existing research addresses this problem that either competition

plays substitution effect or complementary effect for corporate governance in Pakistan

because competition is not very intense. “Businesses hate competition because it limits their

power to manipulate the market, forces them to invest in quality and cuts into their profits”

(Jamal, 2016). However, the corporate sector of Pakistan is characterized by low

competition. Therefore, considering competition in the relationship of corporate governance

with cash holding and value of cash holding respectively would provide important insights.

Similarly, family ownership can also significantly affect the relationship of corporate

governance with cash holding and value of cash holding. The majority of research on family

firms is conducted in the context of developed countries while developing countries are

relatively ignored. Pakistan is not an exception though family firms are dominant in

Pakistan since its independence in 1947. Moreover, Pakistan is an emerging economy

therefore the structure and behavior of family firms is quite different than the developed

countries and therefore, this area needs further insights.

24

Similarly, it is also important to investigate the effect corporate governance on level

and value of cash holding in Shariah compliant firms. “Shariah compliance is gaining

attention among the academicians because Shariah compliance is substitute to the

governance. Theoretically, Shariah compliance is substitute for good governance.

Therefore, this research empirically investigates the effect of corporate governance on level

of cash holding and value of cash holding respectively in Shariah compliant and non-

Shariah compliant firms”.

Corporate governance increases value of firm through efficient utilization of excess

cash. However, the research efforts in this regard are limited. Though, research has been

conducted on effect of corporate governance on utilization of excess cash in U.S.A or using

international data (e.g. Harford et al., 2008; Amman et al., 2011; Jain et al., 2013).

“However, the effect of corporate governance on utilization of excess cash in Pakistan is

relatively overlooked. Similarly, the role of corporate governance on spending of excess

cash in competitive and concentrated industries, family and non-family firms and Shariah

and non-Shariah compliant firms is also ignored in extent literature”. This research

empirically investigates whether good governance promote efficient utilization of excess

cash which leads to increase in firm value.

Moreover, the efficient utilization of excess cash due to good governance

consequently improves firm performance. However, the research efforts in this context are

limited in Pakistan. Therefore, this research investigates the effect of excess cash under

good governance on firm performance in the context of Pakistan. Whether, this relationship

varies across different setting including competitive and concentrated industries; family and

non-family firms and Shariah and non-Shariah compliant firms. However, previous

researches e.g., Dittmar and Mahrt-Smith (2007); Harford et al. (2008); Jain et al. (2013)

used operating profit, while linking excess cash with performance under good and poor

25

governance. Present study besides traditional accounting ratios considers total factor

productivity growth for performance because total factor productivity growth is a stronger

proxy for performance measurement than the operating profit ratio (Tian & Twite 2011).

Similarly, corporate diversification is a major academic issue in both developed and

underdeveloped economies and firms in Pakistan spend excess cash on corporate

diversification. Research shows that diversification decreases value of firm due to agency

problem and Pakistani firms actively engage in corporate diversification. “However, the

effect of corporate diversification on value of cash holding is ignored in Pakistan though

Pakistani firms actively engage in corporate diversification”. Therefore, this research

considers the effect of corporate diversification on value of firm. Moreover, this relationship

is also considered in the context of competitive and concentrated industries, family and non-

family firms, Shariah and non-Shariah compliant firms.

1.4 Objectives of the study

Keeping in view the research gaps the following objectives and sub objectives have been set

for the present dissertation:

1. To investigate effect of corporate governance on cash holding

1(a): To examine the role of product market competition on corporate governance and cash

holding relationship

1(b): To examine the role of family ownership on corporate governance and cash holding

relationship

1(c): To investigate the role of Shariah compliance on corporate governance and cash


2. To investigate the effect of corporate governance on value of cash holding

2(a): To investigate the effect of corporate governance on cash holding in competitive and

concentrated industries

26

2(b): To examine the effect of corporate governance on value of cash holding in family and

non-family firms

2(c): To investigate effect of corporate governance on value of cash holding in Shariah and

non- Shariah compliant firms

3. To investigate the role of good governance on spending of excess cash

3(a): To examine the role of good governance on spending of excess cash in competitive and


3(b): To examine role of good governance on spending of excess cash in family and non-

family firms

3(c): To examine role of good governance on spending of excess cash in Shariah and non-


4. To investigate role of good governance on relationship between excess cash and total

factor productivity growth

4(a): To investigate role of good governance on relationship between excess cash and total

factor productivity growth in competitive and concentrated industries

4(b): To examine role of good governance on relationship of excess cash and total factor

productivity growth in family and non-family firms

4(c): To examine role of good governance on relationship of excess cash and total factor

productivity growth in Shariah and non- Shariah compliant firms

5. To examine effect of corporate diversification on value of cash holding

5(a): To examine whether corporate governance increases value of cash holding in good

governance firms

5(b): To examine that whether corporate diversification increases value of cash holding in

competitive industries

5(c): To examine effect of corporate diversification on value of cash holding in family firms

5(d): To investigate effect of corporate diversification on value of cash holding in Shariah

and non- Shariah compliant firms.

27

1.5 Research Questions

1. (a) What is the effect of corporate governance on level of cash holding?

(b) What is the role of product market competition on corporate governance and cash

holding relationship?

(c) What is the effect of corporate governance on cash holding in family firms?

(d) What is the effect of corporate governance on cash holding in Shariah compliant firms?

2. (a) What is the effect of corporate governance on value of cash holding?

(b) What is the effect of corporate governance on value of cash holding in competitive and

concentrated industries?

(c) What is the effect of corporate governance on value of cash holding in family and non-

family firms?

(d) What is the effect of corporate governance on value of cash holding in Shariah and non-

Shariah compliant firms?

3. (a) What is the role of corporate governance on utilization of excess cash?

(b) What is the role of corporate governance on utilization of excess cash in competitive and

concentrated industries?

(c) What is the role of corporate governance on utilization of excess cash in family and non-

family firms?

(d) What is the role of corporate governance on utilization of excess cash in Shariah and

non- Shariah compliant firms?

4. (a) What is the role of corporate governance on effect of excess cash and total factor

productivity growth?

(b) What is the role of corporate governance on effect of excess cash on total factor

productivity growth in family and non-family firms?

(c) What is the role of corporate governance on effect of excess cash on total factor

productivity growth in Shariah and non-Shariah compliant firms?

5. (a) What is the effect of diversification on value of cash holding?

(b) Does diversification increase value of cash holding in good governance firms?.

(c) What is the effect of corporate diversification on value of cash holding in competitive

and concentrated industries?

28

(c) What is the effect of diversification on value of cash holding in family and non-family

firms?

(d) What is the effect of diversification on value of cash holding in Shariah and non-Shariah

compliant firms?

1.6 Significance of the Study

This study is important in several ways. For example:

First, cash is an important area for both academicians and practitioners in recent era.

Pakistani blue chips companies hold large amount of cash and worry about its spending

(Hussain, 2014). Researchers like Dittmar and Mahrt-Smith (2007); Harford et al., (2008)

shows that due to agency problem cash is destroyed by mangers for their own interest which

ultimately destroys value of firm. Therefore, this study will help academicians and

practitioners to conceptualize the effect of corporate governance on cash holding and value

of cash holding.

Second, corporate governance has got attention from academicians and policy

makers after the crises of Enron; Worldcom and Taj company scandal in Pakistan etc.

Recently the scandal of United Breweries in India is classic example of how bad corporate

governance destroys value of firm and leads big losses for their shareholders. This research

contributes to the existing literature by investigating the role of corporate governance in

cash holding and value of cash holding and how this relationship varies across different

settings. It includes competitive and concentrated industries; family and non-family firms,

Shariah and non-Shariah compliance firms.

Third, this research will provide interesting implications for policy makers and

academia regarding the role played by competition (i.e., being substitute or complementary)

in the relationship of corporate governance and cash holding in Pakistan. Due to importance

29

of competition Government of Pakistan enforce “competition act, 2010” which give power

to competition commission of Pakistan to ensure free competition and discourage such types

of mergers and acquisition which creates monopoly in the market.

Fourth, family controlled firms are significant part of Pakistan economy (Yasser,

2011). The policies of family firms are quite different compared to non-family firms (Alim

& Khan, 2016). This research shows importance of corporate governance in family firms

and established the relationship of corporate governance with cash holding and value of cash

holding in family firms. Fifth, this research also shows the relationship of corporate

governance and cash holding and value of cash holding in Shariah compliant firms. As

research like (Hayat & Hassan, 2017) shows that Shariah compliance firms is alternative to

good governance and mitigate agency problem. Worldwide assets of Islamic industry have

reached from US$ 150 billion in 1990s to US$ 2.2 trillion in the recent years (Hayat &

Hassan, 2017). Moreover, it will touch in US$ 3 trillion in 2020 (“2017 to be the best year

for Islamic financial market”, 2017). This study will help practitioners and academia to

better understand the effect of corporate governance on level of cash and value of cash

holding in Shariah compliant firms.

Sixth, spending of excess cash is among the debatable issues in finance literature

(Dittmar & Mahrt-Smith, 2007; Harford et al., 2008). This study will help academia and

practitioners in understanding the role of corporate governance in utilization of excess cash

and how this role varies in different settings including competitive and concentrated

industries; family and non-family firms; Shariah and non-Shariah compliant firms.

Seventh, this study for the first time links excess cash with the total factor

productivity growth proxy of firm performance. Previous researches used operating profit

ratio while establishing link between excess cash and total factor productivity growth under

30

good governance. Total factor productivity is a better measure than the accounting ratio

(Bath et al., 2005; Tian & Twite, 2011). This study helps in conceptualizing the role of

excess cash in determining the total factor productivity growth under good governance.

Moreover, this research helps in conceptualizing that whether the effects of corporate

governance on excess cash and total factor productivity growth relationship in competitive

industries supports complementary argument.

Moreover this study provides insight about the role of corporate governance on

excess cash and total factor productivity growth in family firms, and Shariah compliant

firms

Finally, this study also has significance in terms of addressing the debate in finance

literature on corporate diversification. Previous researches (e.g., Lins & Serveas, 1999;

Espinosa et al., 2018) shows that diversification exert negative effect on firm value due to

agency problem. This study is important in terms of understanding whether diversification

reduces value of cash holding in developing economy like Pakistan due to agency problem.

Previous studies have considered developed economies while examining the relationship of

corporate diversification and value of cash holding (e.g., Tong, 2011). This study also has

significance for academia and practitioners to understand the effect of diversification on

value of cash holding in competitive and concentrated industries; family and non-family

firms; Shariah and non-Shariah compliance firms.

1.7 Significance in Pakistani context

Pakistan has rules and regulation for investor protection, however; there are

constraints in implementing and enforcing those laws and regulations. An article was

published in Dawn News in 2003 claimed that majority shares are held by the directors or

with people that directors use for proxy (“Minority shareholders to be empowered”, 2004).

31

It is very difficult for minority shareholders to achieve 10% voting right which is necessary

to raise voice to board.

Furthermore, shareholders' activism is very low in Pakistan due to dispersion in

minority shareholders. This makes advantageous for controlling shareholders to appoint

directors that work as a puppet for them (“Giving voice to minority shareholders”, 2012).

Moreover, most of the directors act as the independent directors on other boards that are

why they serve interests of each other. Therefore, for proper governance, SECP is

developing governance codes with the passage of time. The first step for corporate

governance is taken in 2002 while the latest codes are incorporated in 2012.

Similarly, the research efforts are also limited in the context of Pakistan. Studies on

cash holding and value of cash holding are concentrated in developed economies (e.g.,

Opler et al., 1999; Ditmar & Mahrt-Smith, 2007; Pinkowitz et al., 2006; Palazzo, 2012).

However, very little studies have been conducted in the context of Pakistan to investigate

the effect of corporate governance on cash holding and value of cash holding in particular.

Research shows that due imperfect capital market the worth of cash holding

increases. “Pakistan capital market is not developed due to lack of depth, lack of breadth

and crowding out effect” (Nazar & Sarfaraz, 2016). Pakistani market provides an ideal

context for studying cash holding and value of cash holding. Moreover, corporate

governance needs extensive research efforts in Pakistan because giant family firms exist that

tend to fulfill their own destiny at the cost of minority shareholders. Similarly, the corporate

sector of Pakistan is characterized by appointment of non-technical people on the key posts

of the board. Keeping in view these facts this study first time considers relationship between

corporate governance and value of cash holding in Pakistan.

32

Similarly, competition is important for the economic growth of the country and work

as external discipline on mangers. That is why competition commission of Pakistan has

given responsibility and authority to ensure healthy competition in Pakistan. Since, 2007 to

2015 competition commission of Pakistan levied 26 billion Pakistani rupees in the form of

penalty due to violation of competition law (“CCP imposed over RS 26 billion in 8 years,”

2015). Therefore, this study for the first time in Pakistan establishes the relationship of

corporate governance with level of cash holding and value of cash holding in competitive

and concentrated industries. Whether, external market discipline plays substitution or

complementary role for corporate governance in Pakistan.

In Pakistan family oriented firms is dominant since from independence because in

past majority of economy was ruled by 22 big families. Agency problem prevail in family

firms in the form of conflicts of interest between controlling shareholders and minority

shareholders. This study is pioneering in considering the relationship of corporate

governance with value of cash holding in family firms. Similarly, the Shariah compliant

industry is growing all over the world and Pakistan is no exception. This study is the first

attempt towards establishing the relationship of corporate governance with level of cash

holding, value of cash holding, and utilization of excess cash in Shariah compliant firms.

Moreover, studies related to diversification are majorly conducted in developed economies

(e.g., Subramaniam et al., 2011; Tong, 2011). Agency problem is one of the reasons for the

involvement of firms in corporate diversification. Therefore, this study will help the

practitioner in conceptualizing whether diversification with agency cost decrease value of

cash holding?

33

1.8 Contextual Contribution

The dissertation contributes to different aspects of corporate governance and cash

management both in the context of Pakistan and to existing literature.

First, very limited research is available on effect of corporate governance on value

of cash holding in the context of developed economies (e.g., Dittmar & Mahrt-Smith, 2007;

Jain et al., 2013; Uddin, 2016). Moreover, this area is ignored in the context of developing

countries. It for the first time checks the effect of corporate governance on value of cash

holding in Pakistan because there is a divergence in the corporate governance issues of

every economy particularly the developed and developing economies. Masood and Shah

(2014); Basheer (2014); Ullah and Kamal (2017) investigated effect of corporate

governance on cash holding in the context of Pakistan. This research contributed in the

context of Pakistan that it checked whether agency problem leads to high cash holding and

that high cash holding decrease firm value.

Second, it contributes to the literature by answering the research question whether

the effect of corporate governance on level of cash holding and value of cash holding is

different in different industries and ownership structures. For example, this study is the first

attempt to check the role of product market competition on the relationship of corporate

governance with level of cash holding and value of cash holding in Pakistan. The study

basically checks either product market competition is substitute or complement for corporate

governance in the relationship with level of cash holding and value of cash holding. There

is a divergence in the competitive structure of every economy particularly in the developed

and developing economy.

Similarly, family firms are dominant over the globe and Pakistan is not the

exception. The structure of family firms and their governance issues are quite different from

34

non-family firms. The other contribution of this dissertation to the extent literature is that it

also checks the effect of corporate governance on value of cash holding in family firms and

non-family firms in Pakistan. Sheikh and Khan (2015); Alim and khan (2016) investigated

effect of corporate governance on cash holding in family firms in the context of Pakistan.

This research has contribution in the context of Pakistan that it investigated whether

corporate governance increase value of cash holding in family firms.

Shariah compliance is hot debatable issue in corporate finance because Shariah

compliance firms performed better in crises period compare to non-Shariah compliant firms.

The research made valuable addition to the extant literature by answering whether corporate

governance has different effect on level and value of cash holding in Shariah and non-

Shariah compliant firms in context of Pakistan. This dissertation for the first time

investigated substitution role of Shariah compliance for corporate governance in

relationship with cash holding and value of cash holding. Shariah compliant firms are

growing in Pakistan.

Third, the previous research (e.g., Dittmar & Mahrt-Smith, 2007; Jain et al., 2013)

claimed that corporate governance increases value of cash holding through efficient

utilization of excess cash. This research contributes to the extant literature by checking the

effect of corporate governance on utilization of excess cash in Pakistan and whether product

market competition, family ownership and Shariah compliance has role on the relationship

of corporate governance and utilization of excess cash.

Fourth, the previous researches (e.g. Dittmar & Mahrt-Smith, 2007; Jain et al., 2013)

indicate that corporate governance increases future performance of the company due to

efficient utilization of excess cash. The previous researches used operating profitability for

the performance measurement. This dissertation is pioneering in terms of using total factor

35

productivity growth as a proxy of firm performance to check the relationship of excess cash

with firm performance. Total factor productivity growth is superior measure as compare to

operating profit because single accounting ratio has a higher chance of manipulation (Tian

& Twite, 2011).

Finally, this dissertation also enriched research by investigating the effect of

corporate diversification on value of cash holding in Pakistan. The reason is that corporate

diversification is the most dominant form of spending excess cash in the context of Pakistan

among the three way of disgorging excess cash (i.e., industry adjusted change in capital

expenditure, dividend and diversification). Family firms are dominant in Pakistan and

family firms involve in diversification due to family altruism. Similarly, the dissertation is

also pioneering in terms of investigating the effect of corporate diversification on value of

cash holding in good governance and poor governance in the context of Pakistan. Moreover,

the research contributes to extant literature by considering the role of product market

competition, family ownership, and Shariah compliance in the relationship of corporate

diversification and value of cash holding.

1.9 Theoretical contribution

This study is not going to generate new theory. This study follows deductive

approach for theory testing. This research is based on the agency theory (Jensen, 1986)

which is tested in different scenarios. Beside agency theory, precautionary theory (Keynes,

1936) and other theoretical hypotheses i.e., substitution and complementary hypotheses are

also applied. This research basically enriches agency theory through investigating the effect

of corporate governance on cash holding and value of cash holding. Furthermore, to check

the substitution or complementary effect of external market discipline and Shariah

compliant firms are also considered. Substitution effect argument claims that external

36

market discipline is enough to mitigate agency problem despite of firm level poor

governance (Holmstrom, 1982; Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller,

2010, 2011; Guadalupe & Perez-Gonzalez, 2010; Amman et al., 2013). On the contrary,

complementary effect argument claims that reducing agency problem external market

discipline needs efficient firm level governance (Koke & Renneboog, 2005; Jain et al.,

2013).

This research also enriches agency theory and shows the relationship of corporate

governance with cash holding and value of cash holding respectively in family firms.

Family firms have another type of agency problem that is between controlling shareholders

and minority shareholders which arise particularly when the founder or a family member is

appointed on post of CEO or Chairman (Shliefer & Vishney, 1997; Villalonga & Amit,

2006; Villalonga et al., 2015). Moreover, this research also explains the relationship of

corporate governance through three different hypothesis including flexibility hypothesis,

spending hypothesis and shareholder power hypothesis.

Flexibility hypothesis claims that entrenched mangers want to free themselves from

external monitoring and hold high cash (Jensen, 1986). Spending hypothesis explains that

entrenched mangers spend cash rapidly and therefore corporate governance has positive

relationship with cash holding. On the other hand, shareholder power hypothesis posit that

shareholders have confidence on mangers to hold cash in the presence of good governance

(Harford et al., 2008). Therefore, corporate governance has positive relationship with cash

holding according to shareholder power hypothesis.

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1.10 Delimitation of Research

The current study focused effect of corporate governance on different facets of cash

because cash is easily destroyed by managers and controlling shareholders. The current

study focused only non-financial companies and excluded financial sector from sample

because the structure and cash holding behavior is quietly different in financial and non-

financial companies. The study focused Pakistan because the corporate governance issues

and setting is quietly different in developed and developing economies. Furthermore, agency

problem is high in Pakistani companies due to lack of law enforcement and dominancy of

family oriented firms.

The study only emphasizes those attributes of corporate governance which is

common and agreed governance variables in almost all studies. The common variables of

governance provide us generalizable result on the behavior of corporate governance in

competitive and concentrated industries, family and non-family firms, Shariah and non-

Shariah compliant firms. The study only used corporate governance index instead of

individual corporate governance variables in the analysis. This is because index is easy to

interpret and give clear effect for effect of corporate governance on different facets of cash

management in different industries and ownership structures.

1.11 Organization of Study

The first chapter covers introduction of study, second chapter covers literature

review, third chapter covers research methodology, fourth chapter includes result and

discussion and fifth and final chapter covers conclusion of the study.

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CHAPTER 2

LITERATURE REVIEW

The second chapter of dissertation covers literature review. It includes literature on

the effect of corporate governance on level of cash holding, value of cash holding,

utilization of excess cash and performance of firm. This chapter also covers literature on

role of product market competition, family ownership and Shariah compliance in the

relationship of corporate governance and cash holding. Moreover, the literature on effect of

corporate diversification on value of cash holding is also presented.

2.1 Corporate governance and Cash holding

Cash holding is one of the important decisions for firm managers. In case of perfect

capital market the worth of cash is negligible because firm can raise finances easily and with

zero cost through capital market (Opler et al., 1999). This is not the case in real world

because generation of cash to finance firms operation bears some cost. The determinants of

cash holding were properly discussed by Opler et al., (1999) under a framework of trade off

model and financial hierarchy theory.

According to the tradeoff model firms hold extra cash however; it negatively affects

shareholder wealth if the cost of holding cash is greater than return of holding cash. There

are two motive for holding cash including precautionary motive and transaction motive.

According to precautionary motive firms hold cash to prevent themselves from crises and

external shock (Keynes, 1936). In crises period those firms have better survival chances that

have sufficient amount of cash because in crises period firms face difficulty in generating

funds through capital markets (Opler et al., 1999). According to transaction motive, holding

cash by firm is beneficial in the sense to save transaction cost incurred on generation of

39

external financing or cash also mitigate the need for liquidation of assets for payment of

debts (Opler et al., 1999).

On the other hand, the financial hierarchy theory claims that cash and debt has no

optimal level and cash hoarding by company is explained in the context of investment and

as discussed by pecking order theory for financial decisions. Firm’s cheap source of finance

is internal fund and the costly source of financing is equity financing and this is one of the

reason that firms prefer internal liquidity. Variables used in explaining tradeoff model and

hierarchy theory are almost same but their predictive signs are different. According to

tradeoff model capital expenditure has positive relationship with level of cash, while it has

negative sign with level of cash in case of hierarchy theory. In the same way hierarchy

theory consider leverage is substitute of cash and it has negative relationship with cash

(Dittmar et al., 2003). Guizani (2017) investigated determinants of cash holding in

petrochemical and non-petrochemical industries and the result posits that determinants of

cash holding posits significant different effect on cash holding in both industries.

As, the level of cash normally increases with firms due to economic expansion,

mangers of the firms have to decide either the excess cash should be accumulated, or it

should be spent on capital expenditure (i.e., internal investment) or acquisition or should be

disbursed among shareholders (Harford et al., 2008). However, if shareholder wealth

maximization is ignored managers and controlling shareholders expropriate cash for their

personal benefit due to agency problem. The utilization of internal funds is main problem

between mangers and shareholders (Jensen, 1986). Proper corporate governance is needed to

mitigate agency problem between mangers and shareholders. Corporate governance is set of

rules and regulation to conduct business. La Porta, Lopez-DE-Silances, Shilfer, & Vishney

(2000) make definition that “Corporate governance is, to a certain extent, a set of

40

mechanisms through which outside investors protect themselves against expropriation by

the insiders.” They associated “insiders” to both managers and controlling shareholders.

Moreover, corporate governance is a system through which firms control and

monitor the interaction among stakeholders. Another definition on corporate governance

gave by Omran (2004) that “Corporate governance comprises the private and public

institutions (both formal and informal) which together govern the relationship between

those who manage corporations and those who invest resources in corporations. These

institutions typically include a country’s corporate laws, securities regulations, stock-

market listing requirements, accepted business practices and prevailing business ethics”.

The consequences of poor governance may arise in form of business failure. Enron, Lehmon

Brothers, WorldCom and Taj Company Ltd are few examples of business failures caused by

the exploitation of minority shareholders wealth by entrenched mangers and controlling

shareholders. The discussion and study about the effectiveness of corporate governance

address this issue that how entrenched managers’ decision can be brought in line with the

wealth maximization of shareholders.

Agency theory claim that self-interested managers use cash for their own benefit

instead of serving benefit of shareholders. If firm level governance is efficient, minority

interest is protected from exploitation of entrenched managers and controlling shareholders

(Papaioannou, Strock, & Travalos, 1992; Myers & Rajan, 1998; Chen & Chuang, 2009).

Managers and controlling shareholders destroy cash for their own benefit under poor

corporate governance on the cost of minority shareholders (Dyck & Zingales, 2004;

Nenova, 2003). Dittmar and Mahrt-Smith (2007) suggest that cash holding by firms has

increased significantly in the recent years; moreover cash is the important determinant of

overall value of firm. However, firm level governance is changing slowly overtime in

comparison with the high variation in the firm level cash. Therefore, powerful test is

41

demanded to investigate effect of corporate governance on cash holding (Dittmar & Mahrt-

Smith, 2007). The relationship of corporate governance on cash holding is supported by

three hypothesis, which are summarized by Harford et al. (2008) that is 1) flexibility

hypothesis2) spending hypothesis 3) shareholder power hypothesis.

According to the flexibility hypothesis entrenched managers hold high cash because

these managers want to free themselves from outside monitoring (Jensen, 1986) and

shareholders are unable to force managers for low level of cash holding. So, corporate

governance has negative relationship with cash holding. Spending hypothesis claims that in

firms with high agency problem, managers disburse cash in negative NPV projects for their

own benefits that destroy value of firm. So, corporate governance according to spending

hypothesis posits positive relationship with cash holding. Share holder power hypothesis

than claim that minority shareholders have power to exert pressure on managers to work

efficiently. In this case minority shareholders willingly allow mangers for holding high cash

to prevent them from under investment and protect from bankruptcy. Jensen and Meckling

(1976); Myers and Majluf (1984) investigated agency cost in context of information

asymmetry for generating funds from capital market due to information asymmetry exist

between providers of capital and managers. Shareholders should make decision that how

much cash mangers hold to avoid underinvestment problem. In, context of shareholder

power hypothesis corporate governance shows positive relationship with cash holding.

However, empirical literature shows mixed result between corporate governance and

cash holding. Harford et al. (1999) posits that corporate governance has insignificant effect

on level of cash holding. Kalcheva and Lins (2007) used international data and found that

corporate governance has insignificant relationship with level of cash holding. Harford et al.

(2008) conducted research in U.S.A and found positive relationship of corporate governance

and cash holding their result is supported by spending hypothesis. In same way, Liu and

42

Yuan (2018) shows that firm level of corporate governance and financial constraints shows

negative relationship with level of cash holding. Their result further posits that financial

constraint firms with good governance hold less cash. Dittmar et al. (2003) also conducted

research on international data and found that those countries where investors are less

protected hold high level of cash and countries where investors are highly protected hold

less cash. Shareholders pressurize management of company in countries where investor

protection is high to efficiently utilize excess cash especially in form of dividend to the

shareholders. Kusnadi (2011) also investigated effect of corporate governance on cash

holding in family firms and found that high agency problem leads to high level of cash and

lower agency problem leads to low level of cash. Amman et al. (2013) conducted research

on European economies and found negative relationship of corporate governance with level

of cash holding and their result is supported by flexibility hypotheses.

Al-Najar and Clark (2017) conducted research on MENA countries and consider

internal and external governance variables and found that board size has negative

relationship with cash holding. Moreover, firms hold less cash in those economies where

bank has high and strict supervision and international security law standards are followed.

Overall their result shows negative relationship of corporate governance with level of cash

holding. Seifert and Gonenc (2018) conducted a research on international data and

investigated the effect of both country and firm level governance on level of cash holding.

Their result posits that governance of both country and firm level shows negative

relationship with cash holding. Furthermore, Lee and Lee (2009) investigated effect of

corporate governance attributes on level of cash holding and found that firms whose board

size and managerial entrenchment is low hold less cash. Furthermore, independent directors

on board also show negative relationship with cash holding. Roy (2018) conducted research

in India and found that corporate governance has negative effect on corporate cash holding.

43

The result support flexibility hypothesis that posits that governance has negative

relationship with cash holding. Another study conducted by Amman et al. (2013) found that

firm level governance shows negative relationship with level of cash holding. Furthermore,

their study shows that firms under good governance spend less excess cash on internal

investment.

Similarly, the studies that are conducted in Pakistan e.g., Basheer, (2014)

investigated effect of corporate governance variables on cash holding. He found that board

independence has positive effect on level of cash holding, whereas CEO duality and family

dummy shows negative and insignificant effect on level of cash holding. Moreover,

managerial ownership shows nonlinear relationship with level of cash holding. Similarly,

Ullah and Kamal (2017) conducted research to investigate effect of board characteristics on

cash holding and found that corporate governance has negative relationship with cash

holding. In the same way, Masood and Shah (2014) conducted research in Pakistan context

and found board size and proportion of non-executive directors on board shows negative

relationship with level of cash holding and ownership variables shows positive relationship

with cash holding. So, on the basis of above discussion corporate governance and cash

holding has inconclusive results and deduce the following hypothesis.

H1a: Corporate governance has significant effect on level of cash holding

An important question is raised by recent studies that whether effect of corporate

governance on cash holding vary for all industries and all categories of companies. Ullah

and Kamal (2017) found effect of corporate governance on cash holding in big size and

small size firms and dictator and democratic regime. This dissertation investigated effect of

corporate governance on cash holding in competitive industries and concentrated industries;

family and non-family firms and Shariah compliant and non-Shariah compliant firms.

44

2.1.1 Corporate governance, Product market competition and cash holding

This section focuses the role of product market competition on corporate governance

and cash holding relationship. The argument made by theoretical studies present that cash

has advantage for the firms existing in competitive industries. “Deep pockets argument”

develops by Bolton and Scharfstein (1990) on the work of Telser (1966) argues that firms

will compete to their rivals on the basis of internal funds. Therefore, those firms will

successfully survive in product market whose internal cash is available for innovation

because pecking order theory suggests that internal funds are the cheapest and easiest

available source of financing.

Furthermore, cash provide competitive edge to the companies in competitive

environment and enable them to defend themselves from “predatory” actions from their

rivals and discourage new entrants in the market through aggressive actions (Bolton &

Scharfstein, 1990).

Haushalter et al. (2007) argue that firms facing under investment problem in product

market due to insufficient funds lose their market share in the market. Firms operating in

competitive industries raise funds through debt financing and competitors take advantage

from this situation and utilize their internal funds on investment (Chevalier, 1995;

Campello, 2003, 2006). Two hypotheses including the substitution and complementary

effect hypothesis explain the role of product market competition for corporate governance in

relationship with cash holding. Product market competition work as external market

discipline which force managers to work in the best interest of shareholders and increase

firm value despite of high agency problems (Amman et al., 2011; Alimov, 2014). Corporate

governance matters in the industries where external market discipline is weak and shows

substitution effect of product market competition to corporate governance and product

45

market competition work as substitute for corporate governance (e.g., Holmstrom, 1982;

Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller, 2010, 2011; Guadalupe & Perez-

Gonzalez, 2010; Amman et al., 2013). In contrast, Selarka (2014) found competitive effect

of product market competition and shows that external market discipline needs efficient firm

level governance to mitigate agency problem and support complementary effect of product

market competition to corporate governance. On the other hand, Karuna (2007) gave

different explanation of product market competition and corporate governance besides

substitution effect and complementary effect of product market competition. He explained

that basically financial decisions of competitive firms are in the best interest of shareholders

because corporate governance of those firms is good that operate in competitive industries

compared to the firms operating in concentrated industries. Moreover, in competitive

industries firms have more supremacy and require to be monitored. Jain et al. (2013) shows

the joint effect of corporate governance and product market competition on cash holding and

shows corporate governance significantly affects cash holding in competitive industries. So,

on the basis of above discussion this research generated its 2nd hypothesis as following

H1b: Product market competition work as substitute for corporate governance in

relationship with corporate cash holding.

H1b: Product market competition has complementary effect for corporate governance in

relationship with corporate cash holding.

2.1.2 Corporate governance, Family ownership and Corporate cash holding

In recent era family ownership attract attention from academicians and practitioners

due to their importance in terms of corporate decisions. Majority of research focused on

corporate governance and level of cash holding (See for example, Harford et al., 2008;

Dittmar & Mahrt-Smith, 2003; Chen & Chaung, 2009). Corporate governance is very

46

imperative for family firms because family members elect such type of dummy board that

serve the interest of particular family on cost of minority shareholders (Alim & Khan,

2016). However, the literature available on the role of family ownership between corporate

governance and cash holding is very limited and majority of work is done in developed

economies. The structure and role of family ownership is quite different in developing

countries compare to developed countries. The division of control and ownership in family

firms causes reduction in the conflicts of interest between managers and shareholders

(Anderson & Reeb, 2003; Claessens et al., 2000; Fama & Jensen, 1983; La Porta et al.,

1999; La Porta et al., 2000).

There are three perspectives regarding the role of family ownership. First, family

firms resolve agency problems particularly when founder work as CEO or Chairman of the

firm (Villalonga et al., 2015). Lapora et al. (1999) investigated the ownership structure of

the largest 20 companies in 27 economies and found that 69% family firms have CEO or

Chairman belonging to the family tree. Similarly, Claessen et al. (2000) claimed that in 57%

family firms in Asia CEO or Chairman are family members. Volpin (2002) found that in

Italy the key positions belong to particular family in 50% family firms. Villalonga and Amit

(2006) found that family members serve as CEO and Chairman among 66% family firms in

the sample of Fortune 500 family firms.

Secondly, agency conflict between controlling shareholders and minority

shareholders are higher in family firms (Villalonga et al., 2015). Moreover, family firms

engage in family altruism and want to pass business to their successors and expropriate cash

to fulfill firm legacy (Kuan et al., 2011). Similarly, Yeh et al. (2001) suggests that family

firms involve in policies that are fruitful for the controlling family and its family members.

47

Thirdly, the division between cash flow right and control right make controlling

shareholders able to expropriate the resources of firm (Kuan et al., 2011). The controlling

shareholders expropriate firm resources at the cost of minority shareholders. The problem of

agency becomes more severe when family business is inherited to second and third

generation. Research shows that only 15% family businesses continue to exist after third

generation, while the 85% family firms go astray after 3rd generation (Fudda, 2014). In

Pakistan 22 families were dominant in the recent past. However, only few have been able to

uphold their position due to agency problem that destroys overall value of firm.

Family firms involve in family altruism in passing their family businesses to the next

generation. Moreover, family members influence corporate decision of firm to adopt

policies that benefit family members on the cost of minority shareholders (Yeh, Lee, &

Woidtke, 2001). Family businesses make decisions to fulfill the needs and requirements of

particular family (Ward, 1987). Therefore, agency problem is high in family firms compare

to non- family firms. Alim and Khan (2016) shows that family firm’s cash holding is high

compare to non-family firms and lack of proper governance increases the chance of miss-

utilization of high cash for their own benefit. In the same way, Liu, Luo and Tian (2015)

shows that family firms in china hold high cash compare to non-family firms and utilize

cash for their own benefit instead of other shareholders. Kuan et al. (2011) shows that

family ownership causes agency problem when it exceeds a certain level and agency

problem is high between controlling shareholders of a family firm and minority shareholders

instead of between mangers and shareholders. Therefore, there is a need to investigate effect

of corporate governance on cash holding in family firms. For, this purpose the following

hypothesis is deduced.

H1c Corporate governance has significant effect on level of cash holding in family firms

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2.1.3 Corporate governance, Shariah compliance and Cash holding

To check the effect of corporate governance on cash holding in the Shariah

compliant firms is one of the objectives of this dissertation. Islam permits and encourages

Halal business to bring wealth in circulation and break down vicious circle of poverty.

There is clear cut verse in Holy Quran about business “O ye, who belief! Fulfill obligations”

(Al-Maidah:1). “Allah Commands justice, the doing of good, and liberty to kith and kin, and

He forbids all shameful deeds, and injustice and rebellion” (Al-Nahl:90). Islam does not

prohibit profit making activities but on the basis of justice because profit making is the core

objective of any business (Hassan, 2008, Ali, Al-Aali & Al-Owaihan, 2013).

Islamic financial industry is growing rapidly due to increase in the size of Islamic

banks in Muslim majority countries as well as non-Muslim majority countries. Reuters

(2013) claimed that Shariah based financial industry touches 2.2 trillion US dollar.

Recently Islamic finance gained attraction from academicians (Hayat and Hassan, 2017).

During the era of crises Islamic index return beat conventional index return ((Ho et al.,

2014; Bhatt & Sultan, 2012; Jouaber-Snoussi et al., 2012). Baele et al. (2014) shows that

defaulted loan in Islamic banks is low compare to convention banks. In Muslim majority

countries Shariah base banking contribute to financial development (Gheeraert, 2014).

A very limited research has been done on Shariah based non-financial companies

particularly on the effect of corporate governance on cash holding in Shariah compliant

non-financial companies is ignored in extant literature. In Pakistan a company must meet the

following requirements to be included in the list of Shariah compliant firms

(www.meezanbank.com)

1. Debt to asset ratio has maximum limit of 37%

2. Non-compliant investments to total assets should be equal or less than 33%

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3. Non-compliant income to total revenue must be less than 5%

4. Illiquid assets to total assets maximum is 25%

5. Net Liquid Assets To Share Price liquid asset per share should be less than market price per

share

Shariah compliant firms have lower debt to asset ratio compared to the non- Shariah

compliant firms (Hayat & Hassan, 2017). Leverage force managers to work efficiently and

spend corporate resources in best interest of shareholders (Grossman & Hart, 1982; Jensen,

1986). Good corporate governance substitutes leverage because it reduce agency problem

that arise due to conflict between managers and shareholders (Arping & Sautner, 2010;

Jiraporn et al., 2012). Lower levered companies are good governed and Shariah compliant

firms have lower debt as compared to non-Shariah compliant firms (Hayat & Hassan,

2017). On the basis of above argument this research can conclude that Islamic labeled firms

are substitute to good governance.

H1d: Shariah compliance has substitution effect for corporate governance in relationship

with corporate cash holding

Keeping in view the discussion in the proceeding sections (2.1.1 to 2.1.4) a question

arises that whether agency problem leads to high cash and high cash leads to decrease firm

value. The question arise that what is the effect of corporate governance on value of cash

holding? Moreover, how does the effect of corporate governance on value of cash holding

varies across the competitive and concentrated industries; family and non-family firms;

Shariah and non-Shariah compliant firms?.

2.2 Corporate governance and value of cash holding

In the presence of theoretical arguments, empirical research on cash holding and

corporate governance is inconclusive on the fact that whether poor governance leads firms

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towards high level of cash holding. Whether high cash holding with poor corporate

governance decreases firm value (Kalcheva & Lins, 2007). As, per agency theories,

entrenched managers misuse firm resources for their own interest at the cost of minority

shareholders and reduces the value of firm (Jensen, 1986; Dittmar & Smith, 2007; Harford

et al., 2008; Jain et al., 2013). The appropriation of controlling shareholders and entrenched

managers and their investment in value destroying negative NPV projects causes decreases

in firm value (Jensen, 1986; Stulz, 1990; Dittmar & Mahrt-Smith, 2007). Therefore, proper

corporate governance is needed to restrain controlling shareholders from appropriation of

firm resources and damaging firm value (Pinkowitz et al., 2006). The principles of corporate

governance issued by the Organization for Economic Co-operation and Development

(OECD) define corporate governance as “corporate governance involves a set of

relationships between a company’s management, its board, its shareholders and other

stakeholders”.

In history, the scandals of WorldCom, Enron and Taj Company Ltd in Pakistan and

recently 2017 scandal of Blue Bird Air Line Company of India are few examples of agency

problems causing destruction of firm value. Furthermore, the problem of agency is not

restricted to developed or developing economies or any particular industry. The controlling

shareholders and entrenched managers have a persistent tendency to miss-utilize firm

resources and ultimately destroy firm value. Therefore, proper governance rules and

regulation are vital to safeguard the shareholders.

Empirical evidence from literature shows that good governance has positive effect

on firm value. Pinkowitz et al. (2006) used international data and found that countries where

investors are less protected, cash holding posits a negative effect on firm value. On the other

hand, cash holding shows a positive effect on firm value in those countries where investors

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are highly protected. In same way, Amman et al. (2011) conducted cross country research

and founded that good governance leads to low cash and positively affect firm value.

Similarly, Ararat et al. (2017) took Turkish companies for years 2006 to 2012 and found

that good corporate governance has positive and significant effect on firm value. On the

other hand, Kalcheva and Lins (2007) used international data and found that corporate

governance has no significant effect on cash holding and firm value. Chang, Benson, and

Falp (2017) investigated the relationship of cash holding and firm value relationship under

certain criteria (i-e., financial crises, financial constraint firms and corporate governance).

The result posits that cash holding have positive effect on firm value for financial constraint

firms but cash shows weak effect on firm value for financial constraint firms in crises

period. Furthermore, cash shows positive effect on firm value under good governance in

financial constraint firms.

Past researches have calculated firm value through Tobin Q using total asset. The

present research is unique in the sense that it analyzed firm value through cash instead of

total asset because cash is the most significant and valuable part of total assets. Therefore,

value impact through cash is most appropriate compared to Tobin Q (Faulkender & Wang,

2006). Moreover, cash is more easily spent by entrenched managers on their discretion

instead of other types of assets (Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et

al., 2013). Therefore, to investigate the effect of corporate governance on firm value through

cash is important and appropriate instead of considering firm value through other types of

assets (Dittmar & Mahrt-Smith, 2007). Pinkowitz and Williamson (2004) investigated

marginal value of cash using (Fama & French, 1998) methodology and measured value

through market to book ratio. They found that shareholders value cash high in those firms

whose growth opportunities are high and investment opportunities is volatile. Seifert and

Gonenc (2018) adopted the methodology of (Pinkowitz & Williamson, 2004) and their

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result posits that country level governance add to firm value but firm level corporate

governance posits insignificant effect on firm value.

Faulkender and Wang (2006) found value of cash through variation of financial

characteristics using methodology of (Fama & French, 1993) but they used excess equity

return instead of market to book ratio. Further, they divided all independent variables by lag

market value of firm. Pinkowitz et al., (2006) conducted research on international data and

found that cash has significantly increase value of firm in countries where investor’s

protection is high as compare to countries where investor’s protection is weak.

Corporate governance has significant positive effect on value of cash holding and

marginal value of cash is almost double as compare to firms with poor corporate governance

in USA (Dittmar & Mahrt-Smith, 2008). They adopted methodology of Faulkender and

Wang (2006) and shows that marginal value of cash to shareholders for 1USD is 1.62USD

in good governance firms compare to firms with poor governance is 0.42USD. In same way,

Jain et al. (2013) also found that corporate governance increase value of cash holding. On

the other hand, Ward, Yin and Zang (2018) shows that institutional investors increases value

of cash holding but only in those firms where institutional investors weighted investment

and stake is high. So, institutional investor motivation for monitoring plays key role in

increasing value of cash holding. Uddin (2016) conducted research in Japan and found that

foreign institutional ownership increases value of cash holding. Because foreign institutional

ownership has close monitoring on the activities of mangers and restrain mangers from

value destroying decisions which ultimately increase firm value. On the basis of above

discussion this research deduces the following hypothesis.

H2a: Corporate governance has positive and significant effect on value of cash holding

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2.2.1 Corporate governance, Product market competition and Value of cash holding

This study further investigated effect of corporate governance on value of cash

holding in competitive and concentrated industries whether the result varies in competitive

and concentrated industries. Cash is one of valuable asset for the firms that enable firm to

compete in competitive environment and increase firm value. Predation threat-based

theories propose that internal liquidity of funds safeguard firms from rival moves against the

firm without damaging interest of their minority shareholders (Alimov, 2014). On the other

hand, agency based theories propose contrary predictions that high cash in hands of

entrenched managers causes damage to the firm value because they utilize cash in their own

interest instead of serving the interest of shareholders (Jensen, 1986; Dittmar & Mahrt-

Smith, 2007). Bates, Chang and Chi (2018) investigated U.S firms and shows value of cash

holding increases over the period. They further shows that marginal value of cash for one

dollar was $0.61 in 1980 increases in 1990 to $1.04 and it was $1.12 in 2000. The increase

occurred due to various factors (e.g., cash flow volatility, product market competition and

decrease in diversification).

The role of product market competition is discussed by economists and argued that

external market discipline force managers to work efficiently in the best interest of

shareholders. Alchian (1950); Hart (1983) shows that competition increases operating

efficiency of firms by reducing cost of inputs. Shleifer and Vishny (1997) argue that,

“product market competition is probably the most powerful force towards economic

efficiency in the world.” There are two views on the role of product market competition in

the relation of corporate governance and firm value i.e., substitution hypothesis and

complementary hypothesis.

54

The substitution argument claim that good corporate governance has positive and

significant effect on value of cash holding in concentrated industries because external

market discipline is weak in concentrated industries as compared to the competitive

industries (Amman et al., 2011). Moreover, product market competition increases value of

firm despite of firm level of poor governance because competitive force is enough to

mitigate agency problem. On the other side, complementary hypothesis claim that good

governance increase value of cash holding in competitive industries compared to

concentrated industries. This means that external market discipline compensates and

complements good governance, needs efficient governance system to increase value of cash

holding. Chi and Su (2015) shows that value of cash is affected due to predatory threats

face by the firm from their rivals in product market. They show that firms whose predatory

threat is high their value cash holding is also high.

The empirical research conducted by Amman et al. (2011) on international data

suggests that corporate governance has significant positive effect on firm value in

concentrated industries but insignificant effect of corporate governance on firm value in

competitive industries. There result supported substitution argument of competitive pressure

for corporate governance in relationship with firm value. Similarly, Alimov (2014) found

that product market competition has significant effect on value of cash holding. He further

found that product market competition has strong and positive effect on value of cash for

firms that face perdition risk. However, his result shows no support of agency theory and

posits that competition has no effect in good governance and poor governance firms.

Schoubben and Hulle (2013) found that industry competition and industry concentration

both has effect on value of cash holding in weak governance firms. Industry competition and

industry concentration has insignificant effect on value of cash holding in strong governance

firms.

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On the other hand, Jain et al. (2013) supported complementary hypothesis of product

market competition for corporate governance in relationship with value of cash. They

further shows that corporate governance dummy 1 for good governance and 0 for poor

governance has significant positive effect on value of cash in competitive industries.

However, corporate governance has insignificant effect on value of cash holding in

concentrated industries. So, on the basis of previous literature we draw the following

hypothesis:

H2b: Product market competition has substitution effect for corporate governance in the

relationship between corporate governance and value of cash holding.

H2b: Product market competition has complementary effect for corporate governance in the

relationship between corporate governance and value of cash holding.

2.2.2 Corporate governance, Family ownership and Value of cash

Family owned businesses is important part of Pakistani economy. Due to agency

problem controlling shareholders misuse cash on the cost of minority shareholders in family

firms (Ward, 1987; La Porta et al, 1999; La Porta et al., 2000; Yeh et al., 2001).

Consequently, agency problem is high in family firms compared to non-family firms.

Therefore, proper governance is needed to mitigate agency problem in family firms to

increase firm value. Similarly, Boubakar, Derouiche, and Hassen (2015) conducted research

on French family firms and found that family ownership decreases value of cash holding

due to agency problem. Good corporate governance is important for family firms to control

agency problem especially when family businesses are passed to the next generation (Sarbah

& Xiao, 2015).

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On the other hand, Barontini and Caprio (2006) found that founding family firm

increase operating performance and family ownership has no significant relation with firm

value their result does not support agency theory. Mishra, Randoy, and Jensen (2001) found

that founding family ownership has positive effect on firm value, while corporate

governance has no effect on firm value in family firms. On one side, the presence of

controlling family mitigates agency problem between managers and shareholders by

meeting the interest of owners and managers. On the other hand, due to family ownership

another agency problem arise i-e., conflict between controlling shareholders and minority

shareholders (Shliefer & Vishney, 1997; Villalonga & Amit, 2006). The family firms want

to transfer their business to generation after generation. And force the controlling

shareholders to make decision that benefit family shareholders on the cost of minority

shareholders (Buchanan & Yang, 2005) and hamper firm value. Kalcheva and Lins (2007)

found that in firms with high managerial ownership, cash increase firm value when

governance is good but vice versa when external shareholding is low. Similarly, stock

markets react negatively when founder CEO of the firm pass family business to next

generation (Caprio, Giudice, & Signori, 2016). On the basis of the past literature this

research draws the following hypothesis:

H2c: Corporate governance has significant effect on value of cash holding in family firms.

2.2.3 Corporate governance, Shariah compliance and Value of cash holding

Shariah labeled firms are the firms which should meet minimum criteria of Shariah

already discussed in section 2.1.4. The research on corporate governance and value of cash

holding in Shariah compliant firms is negligible in corporate finance literature. Previous

researches show that good corporate governance effect efficient utilization of cash and

ultimately effect value of cash holding (Black, Kim, & Jang, 2006; Beiner et al., 2006;

57

Dittmar & Mahrt-Smith, 2007; Balasubramaniam, Black, & Khanna, 2009; Jain et al.,

2013). Shariah compliant firms are substitute to good governance due to their structure

(Ullah & Rizwan, 2018). The Shariah compliant firms maintain low debt maximum up to

37% and low debt is a substitute to good governance (Hayat & Hassan, 2017; Ullah &

Rizwan, 2018).

Previous researches investigated other financial decisions in Shariah and non-

Shariah compliant firms (e.g., Albdwy, Shah, & Salman, 2014) found that due to restriction

imposed, Shariah compliant does not hamper performance of companies in terms of ROA,

inventory efficiency etc. Moreover, Shariah compliant firms are able to compete with non-

Shariah compliant firms. In the same way Naz, Shah, and Kutan (2017) examined role of

top management on the financial decisions in Shariah compliant firms and non-Shariah

compliant firms using data of Pakistan and UK. They found that top managers take

significantly different financial decisions in Shariah and non-Shariah compliant firms

especially in terms of dividend payment, debt and working capital. Stock market is able to

attract reluctant Muslims for investment due to existence of Shariah compliant firms

(Omran & Pointon, 2004) that increase volume and trade of the market. This study is going

to evaluate effect of corporate governance on value of cash holding in Shariah compliant

firms and non-Shariah compliant firms.

H2d: Corporate governance has different effect on value of cash holding in Shariah

compliant and non-Shariah compliant firms and Shariah compliance is substitute to

corporate governance in relationship with value of cash holding relationship.

2.3 Excess cash and Usage

Utilization of excess cash is one of the most debatable questions in the field of

corporate finance because wasting of excess cash destroys value of firm. Excess cash is the

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difference of actual and predicted cash. The predicted cash is found as residual of regression

of determinants of cash holding i-e cash flow, industry adjusted cash flow volatility,

leverage, networking capital, size, dividend dummy, capital expenditure and market to book

ratio. The excess cash is calculated using Fama and Mechbeth regression following the

variables and work of (Opler et al., 1999).

2.3.1 Corporate governance and uses of excess cash

To finance day-to-day operations it is good to maintain some cash. Cash guards firm

from under investment problem and external financing because external financing is costly

compare to internal financing as suggested by the Hierarchy theory. However, excess cash

has negative effect on value of cash if entrenched managers or controlling shareholders use

it for their personal benefit due to agency problem (Harford et al., 2008; Jain et al., 2013). It

is preferable for firms to maintain high cash if the cost of maintaining high cash is zero

(Fulkender & Wang, 2006). Hierarchy theory supports this logic because internal financing

is cheapest as compare to external financing. However, maintaining excess cash is not cost

free because transaction cost and agency cost is related with maintaining excess cash

(Fulkender & Wang, 2006). Due to poor governance firms spend excess cash on value

destroying investments (Kusnadi, 2011).

Corporate governance effects utilization of excess cash due to which value of cash

holding increases (Ditmar & Mahrt-Smith, 2007; Harford et al., 2008). The three hypotheses

concluded by (Harford et al., 2008) explained the utilization of excess cash i-e., flexibility

hypothesis, spending hypothesis and shareholder power hypotheses. Flexibility hypothesis

suggest that due to agency problem firm’s managers want to maintain high excess cash and

do not invest excess cash to free managers from external market monitoring (Jensen, 1986).

Spending hypothesis claimed that due to agency problem managers involve in over

59

investment and disgorge excess cash on value destroying activities. Shareholder power

hypothesis suggest that whenever shareholders have power on the activities of managers;

prefer high cash to avoid under-investment.

The dissertation checked three ways in which managers disgorge excess cash

including internal investment, dividend, and diversification. Agency theory claims that

entrenched managers disgorge excess cash on value destroying capital expenditures that

benefits managers instead of shareholders. Jain et al. (2013); Harford et al. (2008) shows

that firms with good governance have lower tendency of disgorging excess cash on internal

investment measured by industry adjusted change in capital expenditure. Similarly, Amman

et al. (2011) also found negative effect of corporate governance on capital expenditure.

Next this research investigates the effect of corporate governance on dividend

payout. Dividend payment is less in developing economies compared to developed

economies (Glen et al., 1995). Firms with good corporate governance maintain less cash

because good governance distributes excess cash in form of dividend. According to agency

theory (Jensen & Meckling., 1976; Jensen, 1986) dividend distribution to the shareholders

reduce agency problem because it limited managers to use excess cash for their own benefit.

Laporta et al. (2000) found that countries where investors are highly protected, firms pay

high dividend as compare the firms belong to the countries where investors are less

protected pay low dividend. Two explanations exist in literature on dividend payout

substitution model and Outcome model (Kowalewski, Stetsyuk, & Talavera, 2007).

According to substitution model dividend is substitute to good governance and firms

with high agency problem, investors worry that excess cash can be destroyed on negative

NPV projects by entrenched managers for their own benefits. In that case investors prefer

that excess cash can be distributed in form of dividend to control agency problem. So,

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according to substitution model corporate governance and excess cash interaction has

negative effect on dividend. On the other hand, outcome model portray that firms with good

governance, investors and especially minority shareholders pressurize managers to distribute

excess cash in form of dividend to control over-investment problem. Minority shareholders

like dividend instead of retained earnings in that scenario when minority shareholders are in

position to put pressure on managers for distributing excess cash in form of dividend. On the

basis of outcome model corporate governance and excess cash interaction posits positive

effect on dividend. In line with this assumption, Harford et al. (2008) found that excess cash

and good governance dummy interaction has insignificant negative effect on industry

adjusted change in dividend, while excess cash and bad governance dummy interaction has

negative significant effect on industry adjusted change in dividend. Similarly, Pinkowitz et

al. (2006) found that dividend has positive and significant effect on firm value in poor

governance firms. In contrast Amman et al. (2013) found positive and significant effect of

dividend on firm value in good governance firms as compare to bad governance firms and

their result supported dividend outcome model. Siefert and Gonenc (2018) shows that

corporate governance decreases level of cash holding. Their result shows that excess cash is

distributed among shareholders in form of divided because shareholders in good governance

firms force managers to distribute dividend. They further found that dividend payment to

shareholders increases value of cash holding.

Third way that firm manager can disgorge excess cash is through diversification.

Diversification is major decision that is common occurrence in Asia. According to empire

building hypotheses, firms engage in value destroying diversification to create empire for

their selves which ultimately destroy value of firm. Managers disgorge excess cash in

negative NPV projects due to agency problem (Ditmar and Smith, 2008). Market responds

negatively to the firm engaging in unrelated diversification (Morck, Shliefer, & Vishney.,

61

1990). Agency explanation about diversification shows that due to corporate diversification

firm value decreases (Lang & Stulz, 1994; Comment & Jarrell, 1995; Berger & Ofek, 1995;

Servaes, 1996) because firms spend excess cash on value destroying diversification due to

agency problem. Similarly, Duchin (2010) found that diversified firms have less cash

compared to undiversified firms and especially diversified firms hold less cash when

corporate governance of diversified firms is good. Osech (2011) found corporate

governance has insignificant relation with corporate diversification. Firms with good

governance reduce spending excess cash on diversification. Keeping in view the above

discussion the following hypothesis is proposed:

H3a: Corporate governance has significant effect on utilization of excess cash

2.3.2 Corporate governance, Product market competition and Uses of excess cash

This research investigates the role of corporate governance on utilization of excess in

three ways in competitive and concentrated industries. . First, the utilization of excess cash

in the form of internal investment is considered. Excess cash utilization in form of

investment in the presence of competition is explained in the framework of two theories in

literature predation hypotheses and Agency theory. Predation hypotheses claimed that

competition in product market reduce predatory threats by investing in specific types of

investment (Haushalter et al., 2007). In contrast, agency hypothesis predicts that competition

in the product market force managers to work efficiently and restrain managers from value

destroying investments (Alimov, 2014).

Abdoh and Varela (2018) show that competition in product market force managers

on value investments. Bena et al. (2017) found that competition has significant effect on

capital expenditure. This research investigated effect of corporate governance on utilization

of excess cash in form of capital expenditure, dividend and diversification in competitive

62

and concentrated industries. Oesch (2011) found that corporate governance has insignificant

effect in competitive industries and significant effect in concentrated industries. He found

that corporate governance index and concentrated market dummy shows positive and

significant effect on capital expenditure. His study support substitution effect argument that

corporate governance has significant effect on capital expenditure only in concentrated

industries. Similarly, Jain et al. (2013) found that excess cash in competitive and

concentrated industries shows insignificant effect on industry adjusted capital expenditure.

The complementary hypothesis claim that corporate governance shows significant effect on

capital expenditure in competitive industries compare to concentrated industries.

Second, this research checked the role of corporate governance on utilization of

excess cash in form of dividend in competitive and concentrated industries. The outcome

model of dividend claim that dividend payment is high in competitive market, while

substitution model claim that dividend payment reduce agency problem and that dividend

payment is high in concentrated market. Kao and Chen (2013) found that dividend outcome

model is applied in highly competitive market and competition substitute governance in

Taiwan market. Haw, Ho, and Li (2011) found that countries where investor is less

protected distributed excess cash in form of share repurchases instead of dividend and

reduce marginal value of cash.

Third, this research investigates the role of corporate governance on spending of

excess cash in competitive and concentrated industries in form of diversification. The

research shows that firms normally engage in diversification due to agency problem (Tong,

2011). According to substitution effect argument, firms corporate governance has

significantly reduce spending of excess cash on corporate diversification in concentrated

industries compare to competitive industries. On the other hand, complementary effect

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argument claim that corporate governance significantly reduces utilization of excess cash on

diversification in competitive industries compare to concentrated industries. Atanasova,

Gatev, and Li (2015) investigated corporate diversification and cash holding relationship

and found that when governance is strong, diversified firms hold less cash compare to

undiversified firms. Furthermore, they found that when competition is high diversified firms

maintain more cash compare to stand alone firms. Similarly, Amman et al. (2011)

investigated effect of corporate governance on corporate diversification in competitive

industries and concentrated industries. They found that corporate governance has significant

effect on corporate diverisfication in concentrated industries compared to competitive

industries. Based on the preceding discussion the following hypothesis is proposed:

H3b: Corporate governance has significant role on utilization of excess cash in competitive

industries

2.3.3 Corporate governance, Family firms and Uses of excess cash

The extent literature shows that family businesses have high agency problems

because of lower performance than the non-family firms (Holderness & Sheehan, 1988). In

contrast, Anderson and Reeb (2003) found that family firms have high performance as

compare to non-family firms. La Porta et al. (2000); Yeh et al. (2001) found that family

firms have high agency problem due to which controlling shareholders expropriate firm

resources on the cost of minority shareholders. Corporate governance is needed to mitigate

agency problem for efficient utilization of excess cash in family firms.

Similarly, Boubakar et al. (2015) suggested that family ownership reduced value of

cash due to inefficient utilization of excess cash. Due to agency problem family firms

involve in investments that benefit to family members instead of whole shareholders

especially when family want to transfer business to next generation (Sarbah & Xiao, 2015).

64

This dissertation considers three way of disgorging excess cash i-e industry adjusted change

in capital expenditure, dividend and diversification in family firms.

Family firms have agency problem and involve in value destroying spending of

excess cash in form of industry change in capital expenditure that benefit particular family

on expense of minority shareholders. Good governance in family firms has significant role

in spending of excess cash on industry change in capital expenditure. Derouiche, Hassan,

and Amdouni (2018) `shows that controlling shareholders spend free cash flow less on

investment when the agency problem is low among controlling shareholders and minority

shareholders and vice versa.

The role of corporate governance on spending of excess cash in form of dividend in

family firms is largely ignored in extent literature of finance. Moreover, family firms due to

limited capacity of generating funds from external market prefer retained earnings

(Poutziouris, 2001) compare to dividend. Jensen (1986) claims that dividend is a tool

through which agency problem is mitigated. Moreover, family firms have not as much

savior agency problem between principle and agent (Gugler, 2003; Pindado, Requejo, & De

la Torre, 2012). However, family firms have normally high agency problem between

controlling shareholders and minority shareholders (Faccio, Lang, & Young, 2001; Pindado

et al., 2012). Dividend is a tool to mitigate minority shareholders concerns about miss-

utilization of excess cash. Whenever, firm level governance is good, minority shareholders

raise their voice and pressurize controlling shareholders to distribute excess cash in form of

dividend. Empirical evidence shows mixed result about dividend payment in family and

non-family firms (Chen et al., 2005). The results of Mcconaughy, Mathews, and Fialko

(2001); De Cesari (2009); Wei et al. (2011) shows that dividend payout is low in family

firms compare to non-family firms. In the same way, Duygun, Guney, and Moin (2018)

65

shows that firms with high agency problem prefer low dividend in order to maintain cash for

their discretionary use. They also show that family firms prefer low dividend due to high

agency problem in family firms.

On the other hand, Setia-Atmaja, Teneweski, and Skully (2009); Pindado et al.

(2012) shows that dividend payout is high in family firms compare to non-family firms. In

Pakistan, Shahid, Gul, Rizwan, and Bucha (2016) found that managerial ownership has

positive and significant relationship with dividend. Furthermore, their result shows that

ownership concentration also shows positive and significant relationship with dividend,

while board independence and board size shows insignificant relationship with dividend.

This research empirically investigated role of corporate governance on utilization of excess

cash in family and non-family firms. Whether, corporate governance has significant role in

utilization of excess cash in form of dividend payout in family firms.

As discussed earlier, the third way to disgorge excess cash is through diversification.

Controlling shareholders of family disgorge excess cash through diversification for empire

building for their family on cost of minority shareholders. As, family firms have high

agency problem especially when family is involved in management (Ward, 1987; La Porta

et al, 1999; La Porta et al., 2000; Yeh et al., 2001). Diversification due to agency problem

destroys resources and further destroys firm value (Lang & Stulz, 1994; Comment & Jarrell,

1995; Berger and Ofek, 1995; Servaes, 1996). Family member involve in family altruism to

transfer their business to their heirs as next generation destroy resources of firm and make

such decisions that give benefit only to particular family (Caprio et al., 2016). So, to fulfill

empire building for family and for the next generation family members, family firms

involve in diversification. Proper corporate governance is needed to alleviate agency

66

problem in family firms and thus this research proposed that excess cash under good

governance show negative relationship with diversification in family firms.

H3c: Corporate governance has significant role on utilization of excess cash in family firms.

2.3.4 Corporate governance, Shariah compliance and Uses of excess cash

Shariah compliant firms followed the rules of Shariah, while conducting business

activity and should pass certain criteria as previously discussed in detail. Good governance

enables efficient spending of excess cash (Dittmar & Mahrt-Smith, 2007; Jain et al., 2013;

Balasubramaniam et al., 2009). Shariah compliance is alternative of corporate governance

(Hassan & Hayat, 2017; Ullah & Rizwan, 2018). So, Shariah compliance is alternative to

corporate governance on the basis of these ground, research proposed that Shariah

compliant firms efficiently utilize excess cash and effect firm value. Dividend payment is

high in Shariah compliant firms compare to non-Shariah compliant firms (Farooq & Tbeur,

2013). Shariah compliant firms not only have high dividend payout ratio but also have

likelihood for dividend payment (Farooq & Tbeur., 2013). According to substitution effect

argument Shariah compliance is substitute to corporate governance. On the basis of this

argument corporate governance has insignificant effect on utilization of excess cash in

Shariah compliant firms as compare non-Shariah compliant firms.

H3c: Corporate governance has different effect on utilization of excess cash in Shariah and


2.4 Excess cash, corporate governance, and Total factor productivity growth

Firms waste excess cash due to agency problem that causes decline in performance

of the firm. Dittmar and Mahrt-Smith (2007) shows that excess cash under good governance

increase operating performance and vice versa. Excess cash is wasted by entrenched

67

managers and controlling shareholders for their personal benefit due to agency problem

which consequently decreases operating performance of the company. Proper corporate

governance helps in mitigating agency problem that result in expropriation of excess cash by

entrenched mangers and controlling shareholders (Dittmar & Mahrt-Smith, 2007).

Harford et al. (2008) found that lag excess cash and change in excess cash both

reduce current operating profit of firm. And interaction term of lag excess cash and good

governance dummy has negative relationship with the current industry adjusted profitability

of a company. They explained negative relation in terms of mean reversion of profitability

in long run. Simutin (2010) shows that high excess cash leads to high investment and has

insignificant relationship with future profitability and claimed that it may be due to over-

investment. Jain et al. (2013) portray that excess cash has significant negative effect on

industry adjusted ROA, while governance has insignificant effect on the excess cash and

profitability relationship. This research used the concept of total factor productivity growth

to measure performance of firm. “Productivity as the residual production output beyond the

contribution of input costs is arguably a better measure of the firm's real economic

performance” (Tian & Twite, 2011). Total factor productivity growth is a better measure for

performance than the traditional accounting measures because accounting ratios have higher

chance of manipulation (Barth et al., 2005).

Poor governance tends to decrease productivity growth (Holmstrom & Kaplan,

2005). On the other hand, good governance increases total factor productivity growth by

increasing firm allocated efficiency and encourage managers to invest in value enhancing

investments by keeping cost of capital low (Min & Smyth, 2012). Gaitan, Echeverri, and

Pablo (2018) shows the effect of corporate governance on productivity of Latin American

companies and the result posits that corporate governance effect productivity of firms. This

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research contributes to existing literature by investigating effect of excess cash with good

corporate governance on total factor productive growth. Excess cash with good corporate

governance increases operating profit because good governance ensures efficient utilization

of excess cash (Dittmar & Mahrt-Smith, 2007). The role of good governance on excess cash

and total factor productivity growth is ignored in literature. This research contributes to the

extant literature by investigating effect of excess cash on total factor productivity growth,

and the role of governance in the relationship of excess cash and total factor productivity

growth. On the basis of this argument this research develops following hypotheses.

H4a: Excess cash with good corporate governance positively affect total factor productivity

growth.

2.4.1 Excess cash, Corporate governance, Product market competition and Total factor

productivity growth

It has been discussed that product market competition is external market discipline to

mitigate agency problem between managers and shareholders and increase performance of a

firm (Alchian 1950; Stigler 1958). Competition in product market force managers to work

efficiently and decrease slack of managers (Hart, 1983; Shleifer &Vishny 1997; Allen &

Gale, 2000). Product market competition leads to high total factor productivity growth,

while concentration leads to low total factor productivity growth (Nickell, 1996). Schmidt

(1997) discussed that “other things remaining constant” the output prices reduces due to

competition resulting in the risk of liquidation. Therefore, managers of the firm feel pressure

and work efficiently. Grossfeld and Tressel (2001) found that high competition leads to high

total factor productivity growth using data of polish companies. Similarly, Januszewski et

al. (2002) conducted research in Germany using panel data approach and found that intense

competition increases productivity.

69

On the basis of above discussion it is concluded that competition in product market

leads to increase total factor productivity growth. The role of competition on the corporate

governance and total factor productivity growth is discussed in literature. Two views

presented in literature support the role of governance in competitive and concentrated

industries i-e complementary and substitution effect. According to complementary

hypothesis, corporate governance has significant role in determining the excess cash and

total factor productivity growth in competitive industries. On the other hand, the substitution

view suggests an insignificant role of governance in the relationship of excess cash and total

factor productivity growth in competitive industries because external market discipline is

enough to mitigate agency problem. The substitution hypothesis shows that corporate

governance has significant role in determining excess cash and total factor productivity

growth in concentrated industries compare to competitive industries.

Tian and Twite (2011) conducted research on Australia firms they used data from

years 2000 to 2005 and found that product market competition has substitution effect to

good governance with total factor productivity relationship. They found that external market

discipline increase total factor productivity growth even though firm level governance is

low. Aghion and Howitt (1997) also found that competition has substitution to governance

with total factor productivity relationship. In contrast, Selarka (2014) conducted research on

Indian firms and found weak form of substitution effect of competition for corporate

governance. He suggested that along with competition efficient corporate governance is

needed to improve performance in Indian firms. Januszewski et al. (2002) found that

competition has positive and significant effect on total factor productivity growth and

competition has positive and significant effect on total factor productivity growth for good

governance firms. Their research supported complementary hypothesis of competition with

corporate governance. Similarly, Koke et al. (2001) using data of German firms found that

70

competition has significant effect on total factor productivity in firms having concentrated

ownership. On the other hand, Koke and Renneboog (2005) conducted research using data

of UK and German firms, and found complementary effect of competition for good

corporate governance in relationship with total factor productivity growth. On the basis of

previous researches this research develops the following hypothesis:

H4b: Corporate governance has significant role on excess cash and total factor productivity

growth in competitive industries.

2.4.2 Excess cash, Corporate governance, Family ownership, and Total factor

productivity growth

Agency conflict arises due to division between owners and managers. Disagreement

between owners and managers are classic example of agency problem. In family firms the

conflict between manager and shareholders are less compare to non-family firms (Pindado

et al., 2012) because family members want the business to survive and work as stewards for

the business. On the other hand, a second type of agency problem between controlling

shareholders and minority shareholders is high in family firms compare to non-family firms

(Kuan et al., 2011) and miss-utilization of excess cash that benefit to particular family

members leads to low performance.

Research shows that excess cash is miss-utilized by the controlling shareholders for

their own interest and for the interest of particular family which hampers the performance of

company. Min and Smyth (2012) found that managerial ownership and corporate

governance interaction increases total factor productivity growth. On the other hand,

Cronqvist and Nilsson (2003) conducted research on Swedish firms and concluded that

family ownership decreases the performance of company due to agency problem. Morck,

Shleifer, and Vishney (1988) found nonlinear relationship between managerial ownership

71

and firm performance and measured firm performance through average Tobin Q. In contrast,

Yaseer (2011) investigated effect of corporate governance on firm performance in family

and non-family firm; there result posits that corporate governance has significant role on

firm performance in both family and non-family firms. Barth et al. (2005) investigated effect

of family ownership on total factor productivity. Moreover, they investigated the role of

management on family ownership and total factor productivity. Their result shows that

family firms are less productive compared to non- family firms particularly when the firm is

managed by family members. On the other hand, if family firms hired outsider to manage

firm than family firm and non-family has no significance difference in productivity.

The family firms normally do not want to dilute their ownership and are normally

reluctant in raising new funds through equity financing. Moreover, debt financing is also

low in family owned firms (Agrawal & Nagarjan, 1990; Gallo & Vilaseca, 1996). This

approach makes family firms less productive compared to the non-family firms (Barth et al.,

2005) and decrease overall value of firm. Family members due to agency problems, tend to

work in their personal interest (Yeh et al., 2001) and decrease total factor productivity

growth which ultimately decrease overall value of firm. Therefore, corporate governance

has significant effect on excess cash and total factor productivity growth in family firms. On

the basis of previous studies this research can draw following hypothesis:

H4c: Corporate governance has significant effect on excess cash and total factor

productivity growth in family firms.

2.4.3 Excess cash, Corporate governance, Shariah compliance, and Total factor

productivity growth

This dissertation also investigated role of corporate governance on excess cash and

total factor productivity growth relationship in Shariah and non-Shariah compliant firms.

72

Islam does not prohibit profit and risk minimization but the source of profit must be halal.

The objective of profit is associated with the ethical system of Islam (Noreen, 1988; Rice,

1999; Ali et al., 2013; Emerson & McKinney, 2010). Business according to Islamic

principles and its ethics is much more associated to the moral filter (Rice, 1999). Ethical

system of Islam provides proper guidance for businessman to conduct business in real world

(Ramli & Ramli, 2016). In Islamic ethical system exploitation and overpricing for unjust

profit maximization is discouraged. Hadith of Prophet Muhammad (SWA) “Allah is One

Who fixes prices, Who withholds, Who gives lavishly, and who provides. And I hope that

when I meet Him, none of you will have a claim against me for any injustice with regard to

blood or property”.

. According to substitution effect argument the effect of corporate governance on

excess cash and total factor productivity growth is insignificant in Shariah compliant firms.

Shariah compliant firms have low agency problems due to their structure. Therefore,

managers efficiently utilize excess cash and increase total factor productivity growth.

Lusyana and Sherif (2017) conducted research in Indonesia and found that Shariah

compliance increases the financial performance. Moreover, the investment incurred by

Shariah compliant firms increases their financial performance and stock return.

Kamau (2016) compares the Shariah index with non-Shariah index and found that

performance of Shariah index is better in terms of return per unit risk, excess return and risk

adjusted return compared to non-Shariah index. The work on Shariah compliant firms is

still nascent. Shariah compliant firms have low agency problem. Therefore, consistent with

the substitution effect argument, effect of corporate governance on performance is low in

Shariah compliant firms compared to non-Shariah compliant firms. On the basis of above

73

discussion this research concludes that corporate governance shows insignificant role on

excess cash and total factor productivity growth in Shariah compliant firms.

H4d: Excess cash with good corporate governance has different effect on total factor

productivity growth in Shariah and non-Shariah compliant firms.

Among the three way of spending excess cash i-e industry adjusted change in capital

expenditure, dividend and corporate diversification the important way of spending excess

cash in Pakistan is corporate diversification. The result of this dissertation also proved that

due to agency problem firms involve in corporate diversification that destroys the firm

value. So, the effect of corporate diversification on firm value is important.

2.5 Corporate governance, Diversification and Value of cash

Economists extensively argue that diversification and firm value is related. There is a

debatable literature available in finance that evaluates whether corporate diversification

decreases value of firm. For example, Lang and Stulz (1994); Berger and Ofek (1995) found

that due to corporate diversification value of firm is destroyed because firms involve in

diversification due to agency problems and underutilize excess cash on diversification.

Similarly, Lins and Serveas (1999) conducted research on European economies and found

that value of firm is reduced due to diversification. Moreover, Doukas and Kan (2006)

conducted research in US market and found that value of firm is reduced up to 12% due to

diversification. While, Hund, Monk, and Tice (2010) used global sample and found that

corporate diversification causes 11% reduction in value of firm. Similarly, Cleasssens,

Djankow, Fan, and Lang (1998); Lins and Servaes (2002) targeted Asian markets and found

that value of firm is reduced in Asian economies up to 14% to 16% due to diversification.

Espinosa et al. (2018) found that diversification exerts negative effect on firm value and the

74

negative relationship of diversification and firm value is reversed in the presence of pension

fund administrators and family ownership. Furthermore, presence of large institutional

ownership is unable to reverse the negative relationship of corporate diversification and firm

value.

On the other hand, few researchers found insignificant effect of diversification on

value of firm (e.g., Glaser & Muller, 1998; Zahavi & Lavie 2013). On the contrary, few

researchers like Villalonga (2004); Lee, Hooy, and Hooy (2012) found that diversification

increase value of firm. Diversification has different effect on value of firm in different

economies due to difference in governance structure. Diversification can decrease

performance due to agency cost and information asymmetry (Stein, 1997; Stulz, 1999;

Khanna & Palepu, 2000; Rajan et al., 2000; Campa & Kedia, 2002). Corporate

diversification and firm valuation is negatively related due to agency problem. Denis et al.

(1997) found that diversification reduces value of firm mainly due to agency problem.

Similarly, Riswan & Suyono (2016) investigated effect of diversification and family

ownership on firm value in Indonesia and found that diversification exert negative effect on

firm value, while family ownership shows insignificant effect on firm value. Diversified

firms involve in cross-subsidization to transfer excess cash from profitable projects to less

profitable projects and ultimately destroy value of firm (Lang & Stulz, 1994; Berger &

Ofek, 1995).

The agency explanation of diversification shows that firms expropriate in the form of

diversification for their private benefits (Jensen, 1986). Therefore, good corporate

governance is needed to mitigate agency problem for expropriation of excess cash in form

of diversification. Tong (2011) suggests that diversification is negatively related to value of

cash due to agency problem in lower governance firms, while it has positive but

75

insignificant effect on value of cash holding in good governance firms. He further shows

that marginal value of diversified firms is $0.93 for $1 to the shareholders compare to $1.08

for $1 in undiversified firms and diversification reduces value of cash. Furthermore, his

research shows that good governance increase marginal value of cash to $1.19 from $0.93 in

diversified firms compared to single segment firms whereas, good governance increases

marginal value of cash to $1.20 from $1.08. On the other hand, diversified firms with poor

governance have $0.57 marginal value of cash, while it is $0.86 in single segment firm with

poor governance. On the basis of this argument the research deduces the following

hypothesis.

H5a: Diversification reduces value of cash holding due to agency problem

H5b: Diversification increase marginal value of cash holding in good governed firms and

reduce marginal value of cash holding in poor governed firms due to agency problem.

2.5.1 Corporate diversification, product market competition, and value of cash holding

Product market competition acts as external market discipline to mitigate agency

problem and put pressure on managers to work efficiently in the best interest of shareholders

(Amman et al, 2011; Jain et al., 2013; Alimov, 2014). Researches including Lang and Stulz

(1994); Berger and Ofek (1995); Cleasssens et al. (1998); Tong (2011) suggest that

diversification reduces value of firm due to agency problem. Explanation from the

perspective of agency problem suggests that inefficient spending of corporate resources on

diversification particularly excess cash reduces value of firm. Product market competition

mitigate agency problem and is therefore expected to reverse the negative effect of corporate

diversification on value of cash holding. Therefore, keeping in view the above literature this

study can conclude the following hypothesis:

76

H5c: Corporate diversification has positive effect on value of cash holding in competitive

industries

2.5.2 Corporate diversification, Family firms, and Value of cash holding

According to internal market hypothesis family firms involve in cross-holding,

transferring funds from one place to another where good investment opportunities are

available within family group (Khanna & Palepu, 2000; Anderson & Reeb, 2003; Claessens,

Fan, & Lang, 2006). Moreover, diversification gets benefit from efficient internal market to

relocate finances to good investment opportunities project (Tong, 2011). On the other hand,

agency theory (Jensen, 1986) suggests that family firms due to serving particular family

transfer financing to low investment opportunities projects and even to negative NPV

projects that ultimately destroy value of firm. The Latest scandal is an example of this

phenomenon, where CEO Vajay Malia of family firm in India got involved in unrelated

diversification of airline business from alcoholic beverage business and as a result the firm

value destroyed and the firm faced bankruptcy.

Therefore, the cost of diversification is high due to agency problem where

entrenched managers involve in diversification due to serving their personal interest and

destroy value of firm (Bergen et al., 1992; Koch & Nafziger, 2012). Managerial ownership

destroys value of firm because firms with high managerial ownership involve in bad

diversification due to agency problem (Morck et al., 1988; Lins & Serveas, 2002). When

family firms involve in diversification destroy value of firm because family firms have

agency problem and tend to serve interest of particular family. Therefore, family firms

involve in diversification that benefit to their family members (Brahmana, Setiawan, &

Hooy, 2014). Keeping in view the preceding discussion this research can conclude

following hypothesis.

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H5d: Diversification reduces value of cash holding in family firms.

2.5.3 Diversification, Shariah compliance, and value of cash holding

Diversification reduces value of firm due to agency problem (Denis et al., 1997).

However, as discussed earlier diversification increases value of cash holding in the presence

of good governance (Tong, 2011). Therefore, it can be stipulated that it reduces value of

cash holding in case of poor governance. Since, Shariah compliant firms should fulfill

certain requirements to differentiate from non-Shariah compliant firms. Therefore, Hayat

and Hassan (2017) claim that corporate governance is good in Shariah compliant firms.

Similarly, the substitution effect argument also suggests that Shariah compliance is

substitute to good governance. On the basis of the grounds that Shariah labeled firm is

substitute to good governance this research postulates the following hypothesis:

H5e: Diversification increases value of cash holding in Shariah compliant firms.

2.6 Theoretical framework

Cash has gained more importance after the financial crises of 2008 because those

firms have survived during crises period whose internal liquidity was sufficient. Purpose of

holding cash by firms was explained by Keynes (1936). He explained three purposes of

cash holding 1) transaction motive 2) precautionary motive 3) speculative motive.

Transaction motive shows that firm holds cash for day to day finances, while precautionary

motive claim that firms hold cash to secure themselves from external shocks. Therefore,

cash buffers firms in crises periods where generation of external finances is difficult or

costly. Speculative motive of cash holding explain that firms hold cash to avail sudden

78

opportunities arising in the market. Holding cash is also explained through financial

hierarchy theory which explains that internal funds are cheapest source of finance.

Holding cash is beneficial for firms but some cost is attached with the cash holding.

The important cost that is related with holding extra cash is agency cost. Entrenched

managers destroy cash for their personal interest on cost of shareholders and hence destroy

value of firm (Ditmar & Mart-Smith, 2007; Harford et al., 2008; Amman et al., 2013).

Proper corporate governance is needed to force managers to work in best interest of

shareholders who are the real owners of the firm. This research uses the lens of Agency

theory (Jensen, 1986) to explain the relationship of corporate governance with the level,

value, and utilization of cash.

The corporate governance and cash relationship is explained on the basis of three

hypotheses including the flexibility hypothesis, spending hypothesis and the shareholder

power hypothesis (Harford et al., 2008). According to flexibility hypothesis entrenched

managers due to high agency problem between managers and shareholders, hold cash to

safeguard themselves from external market discipline and monitoring. Therefore, corporate

governance has negative relationship with cash holding. On the contrary, according to

spending hypotheses due to agency problem entrenched managers spend excess cash on

value destroying investments and reduce level of cash. Therefore, corporate governance

shows positive relationship with cash holding. On the other hand, according to shareholder

power hypotheses with good governance shareholder has confidence on managers that they

will not destroy excess cash on value reducing investments. Consequently, corporate

governance has positive effect on cash holding.

Similarly, the role of competition in product market in relationship of corporate

governance and cash holding is supported on basis of substitution and complementary

79

hypotheses. According to substitution effect argument competition in product market work

as external market discipline to mitigate agency problem between shareholder and mangers

and force managers to work in the best interest of shareholders even if firm level governance

is poor (Amman et al., 2013; Jain et al., 2013). Therefore, good governance does not have

important role in competitive industries compared to concentrated industries where external

market discipline is weak. On the other hand, according to complementary hypothesis

efficient internal governance is needed with competition because competition alone is

insufficient to reduce agency problem. Therefore, on the basis of complementary argument

corporate governance has significant effect in competitive industries.

The effect of corporate governance on cash holding in family and non-family firms

is also important to consider. Family firms involve in family altruism and want to transfer

business to their next generation. Therefore, they make decisions that are beneficial to

family members on cost of minority shareholders (Yeh et al., 2001; Kuan et al., 2011).

Therefore, corporate governance has significant effect on cash holding in family firms as

compare to non-family firms to reduce agency problem.

Similarly, Shariah compliance can also affect the relationship of corporate

governance and cash holding. The extant literature suggests that Shariah compliant firms

have low agency problem due to their structure. Therefore, Shariah compliance is alternate

to good governance (Hayat & Hassan, 2017). Hence, according to substitution effect

argument corporate governance has no significant role on cash holding in Shariah compliant

firms

Similarly, corporate governance is also an important determinant of value of cash

holding. Agency problem arise due to conflict of interest between managers and

shareholders that reduces value of cash due to wastage of excess cash for their own benefit.

80

.So, corporate governance increases value of cash holding because corporate governance

significantly effect on efficient utilization of excess cash (Dittmar & Mahrt-Smith, 2007;

Pinkowitz et al., 2006). The effect of corporate governance on value of cash holding and

efficient utilization of excess cash in competitive industries and concentrated industries is

supported by substitution and complementary effect argument. According to the substitution

effect argument, corporate governance has insignificant effect on value of cash holding and

utilization of excess cash which affects value of cash holding. On the other hand, the

complementary argument explains that corporate governance has significant effect on value

of cash holding and utilization of excess cash in competitive industries.

Furthermore, corporate governance has also significant positive effect on value of

cash holding in family firms compare to non-family firms because family firms have

comparatively higher agency problem (Yeh et al., 2001). Therefore, good governance

reduces agency problem and ultimately increases value of cash holding through efficient

utilization of excess cash. Similarly, since Shariah compliance is substitute to good

governance; therefore good governance has insignificant effect on value of cash holding in

Shariah compliant firms. Moreover, corporate governance has also insignificant effect on

efficient utilization of excess cash in Shariah compliant firms.

The extant literature also shows that corporate diversification reduces value of cash

holding due to agency problem (Jensen, 1986). Entrenched managers and controlling

shareholders involve in diversification for empire building on the cost of minority

shareholders. However, diversification has significant positive effect on value of cash

holding in good governed firms and negative effect on value of cash holding in poor

governed firms (Tong, 2011). Therefore, to reduce agency problem proper governance

81

system is needed. Furthermore, competition work as external market discipline and reduce

agency problem.

Therefore, diversification has positive effect on value of cash holding in competitive

industries and negative effect in concentrated industries because external market discipline

is external market force to mitigate agency problem. Diversification in competitive

industries is not value destroying compare to concentrated industries. Similarly,

diversification has negative effect on value of cash holding in family firms. Family firms

involve in diversification under empire building and want to transfer their businesses to next

generation. Therefore, they involve in diversification to benefit particular family members at

the cost of minority shareholders. Therefore, family firms involve in diversification is not

value enhancing due to agency problem. Similarly, the Shariah compliant firms cannot

increases their debt and liquidity from particular target ratio to meet the requirements of

Shariah compliance. Shariah compliance firms due to its structure has low agency problem

compare to non-Shariah compliance firms (Hayat & Hassan, 2017). Therefore,

diversification has either positive or insignificant effect on value of cash holding in Shariah

compliant firms.

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CHAPTER 3

METHODOLOGY

This section includes methodology of dissertation. It includes population, sample size,

variables measurement and analytical models

3.1 Population and Sample size

The governance data is taken from annual reports, while the accounting data is taken

from balance sheet analysis published by state bank of Pakistan from years 2006 to 2014.

Our population consists of 392 companies from various sectors listed on Pakistan stock

exchange (PSX). Sample consists of 196 companies through proportionate sampling

technique. Those industries are selected which have minimum seven firms operating in

industry. Furthermore, miscellaneous sector is ignored because same types of firms are not

operating in this sector. The sample is divided into competitive industries and non-

competitive industries; family and non-family firms; Shariah and non-Shariah compliant

firms respectively. The details of sample firms with respect to their affiliation with different

industrial groups/sectors are reported in Table 3.1.

�1 = �1N ∗ �

�1 = �ℎ ��

�1 = �ℎ �� ℎ ��

N = The size of population

� = �ℎ �� * ��

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Table 3.1: Sample size

INDUSTRIES POPULATION SAMPLE

AUTOMOBILE ASSEMBLER 12 6

AUTOMOBILE PARTS & ACCESSORIES 9 5

AUTOMOBILE PARTS & ACCESSORIES 8 4

CEMENT 22 11

CHEMICAL 28 14

ENGINEERING 18 9

FERTILIZER 7 4

FOOD & PERSONAL CARE PRODUCTS 20 10

GLASS & CERAMICS 11 6

OIL & GAS MARKETING COMPANIES 7 4

PAPER & BOARD 9 5

PHARMACEUTICALS 9 5

POWER GENERATION & DISTRIBUTION 19 10

SUGAR & ALLIED INDUSTRIES 35 18

SYNTHETIC & RAYON 11 6

TECHNOLOGY & COMMUNICATION 10 5

TEXTILE COMPOSITE 56 28

TEXTILE SPINNING 87 44

TEXTILE WEAVING 14 7

Total 392 196

3.2 Variables of the study

3.2.1 Cash Holding

+��ℎ ℎ��* = Cash and Cash equilentsTotal Asset − Cash and Cash equilents

The ratio is used in majority of studies like (Ditmar & Mahrt- Smith, 2007; Harford et al.,

2008; Jain et al., 2013)

3.2.2 Corporate governance measurement

Corporate governance data is collected from yearly annual reports of individual

companies downloaded from their respective websites. Those firms are excluded from the

sample whose data is missing for a particular year. The data for this research is the form of

unbalanced panel.

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For the measurement of corporate governance this research used corporate

governance index (CGI). Corporate governance variables are adopted from Shah (2009).

Corporate governance index measure the quality of corporate governance in firm.

Governance index is measured from various firm level attributes which shows in below

table 3.2. This research measured additive index following the work of Aggarwal et al.

(2011); Amman et al. (2011); Uddin (2016) by dividing the score in 5 quintiles.

Governance index score lies between 1 to 5 and high score represent good

governance, while low score represent poor governance. To obtain robust result reverse

coding is used for negative attributes in index which indicates that increase in governance

score improve corporate governance. Corporate governance score is used to find out the

effect of corporate governance on cash holding. Moreover, to investigate the effect of

corporate governance on value of cash holding, governance dummy is used 1 for good

governance and 0 for poor governance. The dummy variable is used because in value of

cash holding regression interaction of corporate governance dummy and change in cash is

used following the work of (Faulkender & Wang, 2006; Dittmar & Mahrt-Smith, 2007).

The objective of the study is whether change in cash increase marginal value of cash under

good governance and reduce marginal value of cash under poor governance.

Moreover, researchers suggest that better way to create interaction term is that one

variable is in continuous form and other is in dummy form because it is easy to interpret

whether change in cash add value to the firm under good governance. Furthermore,

governance dummy is also used in interaction of lag excess cash and corporate governance

dummy to find its effect on utilization of excess cash and performance of firm under good

governance. Corporate governance dummy is created by dividing the firm’s governance

index into 3 terciles. The highest tercile is given 1 for good governance and lowest and

85

middle tercile is given 0 for poor governance in particular year. Table 3.2 reports the

corporate governance variables used for CGI.

Table 3. 2: Corporate Governance Variables

Ownership

Structure

OS Shares held by board of

directors/ Total no. of shares

outstanding

Board Size BS Ln. of total No. of Board

members.

Board

Independence

BI Non-Executive Directors/

Total No. of Directors in

board

Audit Committee

Independence

Audit committee size

ACI

ACS

Non-Executive directors in

Audit committee/ Total

Audit size

No. of Directors in Audit

Committee

CEO Duality

Board meeting

CEOD

BM

Whether CEO and Chairman

is the same person.

Number of board meeting

per year

3.2.3 Diversification measurement

Firm diversification is measured when the group of firms is operated in different

industries like Sitara chemical limited and Sitara textile limited. Dummy variable is used

for diversification with 1 for diversified firms and 0 for standalone firms.

86

3.2.4 Product market competition

As, per previous literature product market competition is measured through

Hirfindahl-Hirschmann Index (HHI) (Masulis et al., 2007; Giroud and Mueller, 2010, 2011;

Amman et al., 2013; Jain et al., 2013; Alimov, 2014). HHI is concentration measure and

computed by dividing total sales of company in a particular year by total sales of the

industry to which the firm belongs and square that market share of all firms in particular

industry for particular year. Sum square of all market shares of all industries are divided in

terciles. Moreover, firms in particular year belong to lowest tercile industries is assigned 1

for competition and otherwise 0 for concentration. This research exclude firm in particular

year whose sales figure are missing. The binary value of 1 and 0 is used because to divide

industries in particular year in competitive and concentrated and check the substitution and

complementary effect of product market competition for corporate governance in various

relationships.

Shariah compliance is captured through dummy variable with 1 for Shariah

compliant firms and 0 for non-Shariah compliant firms. Data for Shariah compliant firms is

collected from PSX-KMI.

Family ownership is measure on the basis of certain criteria (1) if insider has 25% or

more ownership suggested by (Kuan et al., 2011) (2) if the firm CEO or Chairman is

founder or successor is assigned for family and 0 for non-family firms.

3.2.5 Control variables

This research takes data for financial ratios from years 2006 to 2014 from the annual

reports and balance sheet analysis of Pakistan. The control variables are selected on the

basis of precautionary motive of cash holding used by (Opler et al., 1999) and variables is

87

further used by various researchers (like- Dittmar et al , 2003; Aggarwal et al., 2011; Shah,

2011). The control variables for corporate governance and cash holding relationship are as

following:

i. Cash flow is measured as the profit after tax and dividend but before depreciation, divided

by net assets

��ℎ��1 = net profit before tax − tax expense − dividendtotal asset − cash

ii. Industry cash flow volatility is measured through standard deviation of past 3 years cash

flow and calculated the median standard deviation of each industry for each year and then

subtract industry median from the standard deviation of each firm cash flow on yearly basis.

iii. Market to book ratio measured the growth opportunities of the firm

��7� �� 7 �� = Market value of assetBook value of asset

iv. Leverage ratio shows total debt to book value asset ratio which shows total debt financing of

the firm in particular year.

�;��* = Total debtBook value of assets

v. To measure Net working capital current liabilities are subtracted from current asset and

divided by book value of asset

�� 1��7��* �� = Current Asset − Current Liabilitiestotal asset − cash

vi. Size of the firm is measured as natural log of the book value of asset

Size = ln(Total asset)

vii. Capital expenditure is measured as annual change in fixed assets plus annual change in

depreciation divide by net assets

+��= = Δ annual fixed asset + depreciation chargestotal asset − cash

88

Dividend is dummy variable which is equal to1 if firm pays dividend in particular year

otherwise 0.

3.3 Panel data analysis

3.3.1 Static model

Panel data technique is used for the analysis of data. Panel data technique has

advantage over cross-section and time series data due to heterogeneity. Panel data has low

chances of heterogeneity compared to cross-sectional and time series data (Baltagi, 2008).

Furthermore, multicolineairity problem is less in panel data compared to time series and

cross sectional-data (Baltagi, 2008). According to Peterson (2006) 42% of research papers

in finance do not care about the independence of residual. If residual is identical and

independent than OLS estimates is unbiased otherwise OLS estimates are biased. And if

both firm fixed effect and time effect exist the phenomenon can be captured for unbiased

standard error by including time dummies and cluster by firm or industry (Peterson, 2006).

This study follows this phenomenon by including time dummies, industry fixed effect and

standard error cluster to firm. The phenomena are also used by various researchers, while

investigating effect of corporate governance on cash holding (e.g., Harford et al., 2008; Jain

et al., 2013; Alimov, 2014; Uddin, 2016). The problem of endogeneity also exists in the

relationship of corporate governance and cash holding because corporate governance and

cash is jointly determined (as suggest, Harford et al., 2008). The OLS estimation is not fully

able to control endogeneity problem and to counter endogeneity problem dynamic panel

model is used in previous researches.

89

3.3.2 Dynamic model

Dynamic model involves dynamic effect in panel model by adding lag of the

dependent variable in the regression. The dynamic panel data model gives more

generalizable results in panel data (Wooldridge, 2001). Two models among the dynamic

panel models are extensively used in finance literature i-e.; two stage least square (2SLS)

and generalized least square model (GMM). 2SLS estimation required instrumental

variables but the problem is that past researches used identical variables in the relationship

of corporate governance and cash holding. So, it is difficult to find proper instrumental

variables for the relationship of corporate governance and cash holding (Harford et al.,

2008). So, GMM is superior approach which does not require instrumental variables. Two

approaches are widely used in literature for GMM including the Arellano-Bond and

Arellano-Bovver approach. Individual effect built-in differently in both approaches,

Arellano-Bond method follows differencing approach, while Arellano-Bovver approach

follows orthogonal deviations. In recent research Arellano-Bovver method is normally used

due to strength for small sample size and it is also good when data is non-stationary.

3.3.2.1 Instrumental validation

Validity testing is required for both system GMM and difference GMM. Arellano

and Bond (1991) suggested test for serial correlation in disturbance effect because

disturbance effect of serial correlation sometime affects validity of instruments. The null

hypothesis for this test is that there is no autocorrelation. The second test is for identification

of over-identification problem through Sargan test (Sargan., 1958). The null hypothesis of

the test is over-identification restrictions are valid.

90

3.4 Analytical model

The following basic analytical models are used;

+��ℎ ℎ��*A,C =∝ +EF��1A,C + EG+HIA,CJF + EK L��MA,C + EN �O+A,C

+EP��A,C + EQ�;��*A,C + ERS+A,C ∗ +HIA,CJF + ETS+A,C + EU��;��A,C + EFVW�;A,C +EFF��=A,C + �A,C………………………………………………………..(3.1)


+EP��A,C + EQ�;A,C + ER�� A,C ∗ +HIA,CJF + ET�� A,C + EU��;��A,C +EFVW�;A,C + EFF��=A,C + �A,C……………………………………………….(3.2)


+EP��A,C + EQ�;A,C + ER�ℎ��ℎA,C ∗ +HIA,CJF + ET�ℎ��ℎA,C + EU��;��A,C +EFVW�;A,C + EFF��=A,C + �A,C……………………………………………….(3.3)

+HIA,CJF = Corporate governance index of firm “i” at time t-1

L��MA,C= market to book ratio of firm “i” at time t

�O+A,C= net working capital of firm “i” at time t

X��A,C= size of firm “i” at time t

Y;A,C= leverage of firm “i” at time t

S+A,C= product market competition dummy of firm “i” at time t

Z� ��A,C= family ownership dummy of firm “i” at time t

Xℎ��ℎA,C= Shariah compliance dummy 1 for Shariah compliance and 0 for non-Shariah

compliance of firm “i” at time t

W�;A,C=dividend dummy of firm “i” at time t

+��=A,C= capital expenditure of firm “i” at time t

91

3.5 Value of Cash holding

This research follows the work of Faulkender and Wang (2006); Dittmar and Mahrt-

Smith (2007) to investigate the effect of corporate governance on value of cash holding.

Furthermore, to investigate effect of corporate governance on value of cash holding in

competitive and concentrated industries; family and non-family firms; Shariah and non-

Shariah compliant firms. The research basically investigated that whether firm value

changes due to changes in cash holding. The change occurred in value of firm is measured

through excess return and calculated as return of firm “i “during year t minus bench mark

portfolio return to which stock “i ” belongs during year. The portfolio of bench mark is 25

Fama and French portfolios created on basis of size and book-to-market ratio. This research

basically measure value of firm with respect to change in value of firm due to change in

cash. The dependent variable is excess return and main independent variable is change in

cash to which lag cash, market leverage and governance is interacted and independent

variables is divided by lag market value of equity. The division of independent variables by

lag market value of equity enable researcher that the coefficient of change in cash is

interpreted in a way that one extra Pakistani rupee result how much change in wealth of

shareholders. To determine the effect of good governance on excess return, governance

dummy 1 for good governance and 0 for poor governance is interacted with change in cash

scale by lag market value and regressed on excess return. This research expects that

interaction of good governance and change in cash to market value shows positive effect on

excess return. The researcher may expect that holding of extra Pakistani rupee will increase

value of firm in the presence of good governance. The expected coefficient of interaction

between good governance dummy and change in cash shows the change in firm value

through cash in presence of good governance. The regression of value regression shows

marginal change.

92

[A,C − [MA,C =∝ +EF⊿+\A,CL]A,CJF

+ EG+HIA,C + EK+HIA,C ∗ ⊿+\A,CL]A,CJF

+ ENI;A,C + EP⊿^��*A,C

L]A,CJF

+ EQ⊿W�;��A,C

L]A,CJF+ ERY;A,C ∗ ⊿+\A,C

L]A,CJF+ ET

⊿��_��A,CL]CJF

+ EU+\A,CJFL]A,CJF

∗ ⊿+\A,CL]CJF

+ EFV⊿IA,C

L]CJF+ EFF

+\A,CJFL]CJF

+ EFG⊿��_��A,C

L]CJF+ +ƲA,C

[A,C − [MA,C =∝ +EF⊿abc,d

efc,dgh+ EG��;�A,C + EK��;�A,C ∗ ⊿abc,d

efc,dgh+ ENI;A,C +

EP⊿ijklAlmc,d

efc,dgh+ EQ

⊿nAoApqlprc,defc,dgh

+ ERY;A,C ∗ ⊿abc,defc,dgh

+ ET⊿sqCtrrqCc,d

efdgh+

EUabc,dghefc,dgh

∗ ⊿abc,defdgh

+ EFV⊿uc,d

efdgh+ EFF

abc,dghefdgh

+ EFG⊿sqCtrrqCc,d

efdgh+ ƲA,C………(3.5)

⊿X shows change in control variables form t-1 to t. [A,C indicates stock return of

company i from t-1 to t. [MA,CFama and French (1993) size and book-to-market matched

portfolio return from year t-1 to t. L]A,CJF shows the lag market value of equity and ⊿+\A,C

shows change in cash from t-1 to t, where ⊿^��*A,C shows change in earning from t-1 to

t and measured as earning before extra-ordinary items. ⊿W�;�� show change in

dividend from t-1 to t and I; shows market leverage which is measured as total debt

divide by total debt plus market value of equity at time t. +\A,CJF shows cash at time t-1 and

⊿��_��A,C shows change in net asset from t-1 to t and is measured as total asset minus

cash. CGI which is main variable of interest shows corporate governance dummy and

measured by dividing corporate governance index in three terciles 1 for firms that lies in

highest tercile at particular year and 0 for firms that lies in middle and lowest tercile at

particular year. Diver shows corporate diversification which is measured through dummy

variable with 1 for diversified firms and 0 for stand-alone firms. For the effect of corporate

diversification on value of cash holding the same control variables is used as it is used in

effect of corporate governance and value of cash holding relationship. The reason is that it is

93

the most common variables used by various researchers as determining value of cash

holding (e.g., Faulkender& Wang, 2006; Dittmar & Mahrt-Smith, 2007; Tong, 2011; Jain et

al., 2013; Alimov, 2014). Furthermore, the objective of research is to investigate whether

corporate diversification add firm value through cash?

3.6 Analytical model for spending excess cash

The research shows that value of firm increases through efficient utilization of

excess cash and good governance effect efficient utilization of excess cash. This research

considers three way of utilization of excess cash i-e industry adjusted capital expenditure;

dividend and diversification.

⊿��+��=A,C =∝ +EF^=��A,CJF + EGH�;A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C +EP L��MA,C+EQ��A,C + ER�;A,C + +ET��1A,C + EU��;A,C + �A,C………(3.6)

W�;A,C =∝ +EF^=��A,CJF + EGHv]A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C +EP L��MA,C+EQ��A,C + ER�;A,C + +ET��1A,C + EU��;A,C + �A,C…………(3.7)

W�;�A,C =∝ +EF^=��A,CJF + EGH�;A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C + EP L��MA,C+EQ��A,C + ER�;A,C + +ET��1A,C + EU��;A,C+ �A,C … … . (3.8)

⊿��}+��=A,C shows the change in industry adjusted capital expenditure from year t-1 to

t that is measured as median of capital expenditure calculated for the particular year and

subtracted from the firm capital expenditure for that year.

W�;A,C shows firm dividend 1 for dividend paying firm and zero non-paying dividend firm

Diveri,t is corporate diversification of firm i at time t.

^=��A,CJF represents excess cash which is calculated as residual of (Opler et al., 1999)

equation which is given in appendix1.

94

Hv]A,CJF represent governance dummy 1 for good governance and 0 for poor governance

and

L��MA,C shows market to book ratio.

�;A,C is leverage ratio

��1A,C is the cash flow of the firm i at time t

��;A,C industry adjusted volatility of firm i at time t.

3.7 Analytical model for governance and total factor productivity growth

To analyze that excess cash under good governance increases total factor

productivity growth. Total factor productivity growth is used to measure the performance of

the company.

�ZSHA,C =∝ +EF^=�� ℎA,CJF + EG*�;A,CJF + EK��1A,CJF + EN�O+A,CJF + EP L��MCJF+EQ��CJF + ER�;CJF + ET^=�� ℎCJF ∗ *�;CJF+ EU��;A,CJF + EFV��=A,CJF + �A,C … … … … … (3.9)

3.7.1 Total Factor Productivity Growth

Fare et al (1994) proposed Malmquist index which measures total factor productivity change

between two time periods.

VC (1r, =r, 1C, =C) = p�d (�d�d)p�d (�d�d)

The symbol s is the point for reference technology while t point shows base technology.

Collie et al (2005) remove the restriction in selection of one technology in these two

technology malmquist index for total factor productivity become as

�(1r, =r, 1C , =C) = �p�� (�d,�d)p�� (��,��) × p�d (�d,�d)

p�d (��,��)

95

The value of � greater than 1 indicates positive total factor productivity growth.

And value of � less than 1 indicates deteriorating total factor productivity. This means

that either positive growth occurs between base period and reference period or it become

more worst

Tfpch= Effch× Tch

This refers that there are two sources of total factor productivity change including

efficiency change and technological change therefore; it is constant return to scale.

Furthermore, for more insight into the sources of efficiency change we impose variable

return to scale assumption. According to this assumption efficiency change is further

decomposed into pure efficiency change and scale efficiency change. The pure efficiency

change is as follow.

PTECH = p��d (�d,�d)p�� ,��

The scale efficiency change is as follow.

SECH = �p��d (�d,�d)/p��d (�d,�d)p��d (��,��)/p��d (��,��) × p�� (�d,�d)/p��d (�d,�d)

p�� (��,��)/p�� (��,��)�F/G

Scale efficiency change refers to the geometric mean between the two periods scale

efficiency i.e., change period’s s and t. The symbol “v” and “c” shows two basic

assumptions i.e., constant return to scale and variable return to scale. The value of scale

efficiency greater than 1 indicates positive efficiency change and value less than 1 indicates

deteriorating behavior. In the same way the value of pure technical efficiency change greater

than 1 shows a positive change in technical efficiency, while less than 1 indicates

deteriorating behavior.

96

3.7.2 Input and Output for total factor productivity growth

The dissertation used the output and inputs following Feroz, Kim, and Raab (2003);

Raheman, Afza, Qayyum, and Bodla (2008).They used sales revenue as output and total

assets, cost of goods sold, shareholder expenses and shareholders’ equity as inputs.

97

CHAPTER 4

RESULT AND DISCUSSION

This chapter presents the findings and discussions of the study. The effect of

corporate governance on level of cash holding and value of cash holding is discussed in

section 4.1 and 4.2 respectively and how this relationship vary cross different settings

including product market competition, family ownership and Shariah compliance. In the

section 4.3 the role of corporate governance on utilization of excess cash is discussed.

Moreover, their relationship is investigated in competitive and concentrated industries;

family and non-family firms; Shariah and non-Shariah compliant firms. The three ways of

utilization excess cash is considered i.e., industry adjusted in capital expenditure, dividend

and diversification. In section 4.4 the role of corporate governance on excess cash and firm

performance is discussed in competitive and concentrated industries; family and non-family

firms; Shariah and non-Shariah compliant firms is discussed. Finally, the effect of corporate

diversification on value of cash holding is discussed in section 4.5 in the context of well

governed and poorly governed firms; competitive and concentrated industries; family and

non-family firms; Shariah and non-Shariah compliant firms

4.1 Effect of corporate governance on Cash holding

This section presents the results corresponding to objective 1 and sub-objectives 1a,

1b, 1c. Table 4.1 presents descriptive statistics of the data used for this purpose

98

Table 4. 1: Descriptive Statistics

Variable Fullsample Comp Conc Shariah Nonshariah Family Nonfamily

Cash 0.054 0.041 0.078 0.067 0.042 0.048 0.071

(0.115) (0.095) (0.142) (0.123) (0.106) (0.120) (0.100)

CFLOW 0.095 0.088 0.107 0.106 0.083 0.088 0.112

(0.112) (0.102) (0.127) (0.101) (0.121) (0.108) (0.121)

INDCV 0.010 0.012 0.008 0.008 0.013 0.009 0.014

(0.051) (0.053) (0.046) (0.038) (0.061) (0.052) (0.049)

Lev 0.552 0.555 0.546 0.365 0.583 0.556 0.540

(0.201) (0.198) (0.207) (0.188) (0.209) (0.190) (0.229)

NWC 0.039 0.031 0.053 0.056 0.022 0.024 0.080

(0.218) (0.210) (0.233) (0.201) (0.233) (0.199) (0.259)

Div 0.588 0.556 0.646 0.620 0.557 0.570 0.637

(0.492) (0.497) (0.479) (0.486) (0.497) (0.495) (0.482)

Govindex 0.453 0.465 0.431 0.439 0.467 0.466 0.417

(0.198) (0.202) (0.191) (0.206) (0.189) (0.193) (0.208)

Size 15.465 15.127 16.084 15.750 15.185 15.278 15.972

(1.491) (1.252) (1.686) (1.529) (1.397) (1.352) (1.716)

MtoB 0.066 -0.001 0.188 0.092 0.039 -0.026 0.313

(0.606) (0.602) (0.595) (0.528) (0.672) (0.494) (0.785)

CAPEX 0.064 0.058 0.074 0.066 0.061 0.062 0.068

(0.045) (0.025) (0.067) (0.051) (0.039) (0.040) (0.057)

First term is mean and second term in bracket is standard deviation. The second column shows

descriptive statistics for full sample. Third column represents firms belonging to competitive industries

which are measure through HHI lowest tercile is competitive industry and middle and highest tercile is

concentrated industries. Fourth column shows firms belonging to concentrated industries; fourth column

shows Shariah compliant firms. Fifth column shows non-Shariah compliant firms. Sixth column shows

family firms and seventh column shows non-family firms. cflow stands for cash flow, indcv stands for

industry adjusted cash flow volatility, lev stands for leverage, nwc stands for net working capital, div

stands for dividend 1 for dividing paying firm at particular year and 0 for non-paying dividend forms at

particular year. Size stands for size of firm, mtob stands for market to book ratio and capex stands for

capital expenditure

Table 4.1 shows descriptive statistics of all variables. The first term in each cell is

mean while the second term in bracket is standard deviation. Second column shows full

sample, third column shows firms belonging to competitive industries which are measure

99

through HHI lowest tercile is competitive industry, while middle and highest tercile is

concentrated industries. Fourth column shows firms belonging to concentrated industries;

fifth column shows Shariah compliant firms, sixth column shows non-Shariah compliant

firms, seventh column shows family firms and eighth column shows non-family firms.

Cash holding which is measure cash divide by net asset.

The descriptive statistics indicate that companies hold less cash in competitive

industries compared to firms in concentrated industries. Moreover, firms from competitive

industries have less leverage, networking capital, size, dividend and capital expenditure

compared to the firms belonging from concentrated industries. Furthermore, the descriptive

statistics also shows mean and standard deviation values of variables between family owned

firms and non- family owned firms. The result shows that family owned companies have

comparatively lower cash, cash flow and industry adjusted cash flow volatility, market to

book ratio and capital expenditure than non-family firms. Moreover, they have high

leverage, networking capital and good governance score compare to non-family firms. Table

4.1 also shows descriptive statistics of variables in Shariah compliant firms and non-

Shariah compliant firms. The result shows that Shariah compliant firms have high cash

holding, high cash flow and high dividend, market to book ratio and governance index

compared to non- Shariah compliant firms. The result also shows that Shariah compliant

firms have low leverage, networking capital compared to non Shariah compliant firms,

while capital expenditure is not different in the Shariah and non- Shariah compliant firms.

Table 4.2 shows effect of corporate governance on cash holding and the role of

product market competition, concentration, family ownership and Shariah compliance

respectively in the corporate governance and cash holding relationship. Table 4.2 reports

results of five models. Dependent variable for each model is corporate cash holding which is

measured as cash holding divide by net asset. The purpose of each model is as follows:

100

Model 1 shows effect of corporate governance index on cash holding. Model 2

shows role of product market competition in the relationship of corporate governance and

cash holding. Product market competition is measured through HHI index which is divided

in tercile the lowest tercile is assigned 1 which measured competition and other wise 0.

Model 3 shows effect of concentration on corporate governance and cash holding

relationship. Concentration is the highest and middle tercile which is assigned 1 otherwise 0.

Model 4 shows role of corporate governance on cash holding in family and non-family

firms. Family ownership is measured through dummy variable 1 for family firms and 0 for

non-family firms. Model 5 shows role of Shariah compliance in corporate governance and

cash holding relationship. Shariah compliance is measured through a dummy variable with

1 for Shariah compliant firms and 0 for non-Shariah compliant firms.

Each model has eight controlled variables including: cash flow (cflow) , industry

adjusted cash flow volatility (indcv), market to book ratio (mtob), size of the firm (size),

leverage of the firm (lev), net working capital (nwc), capital expenditure (capex) and

dividend (div). All models data is winsorized at 1% and 99%.

All tables are created on APA style and also format of tables is adopted from

(Harford et al., 2008, Jain et al., 2013; Uddin, 2016; Ullah & Kamal, 2017).

Table 4.2: Effect of corporate governance on cash holding (Dependent variable: Cash holding)

Cash model1 model2 model3 model4 model5

Govind -0.325 *** 0.162

-0.361 ** 0.034

-0.196 **

(0.089) (0.151)

(0.157)

(0.186)

(0.091)

Comp

0.168 *

(0.098)

comp*govind -0.523 ***

(0.178)

Conc

-0.168

(0.108)

conc*govind 0.523 **

(0.254)

Family

-0.046

(0.042)

101

family*govind -0.368 *

(0.208)

Shariah

0.085

(0.109)

sharia*govind -0.107

(0.214)

Cflow 0.908 *** 0.986 *** 0.986 *** 0.893 *** 0.998 ***

(0.238) (0.225)

(0.304)

(0.221)

(0.234)

Indcv 0.926 0.653

0.653

0.657 ** 0.670

(0.439) (0.399)

(0.591)

(0.420)

(0.410)

MtoB 0.380 *** 0.239 *** 0.239 *** 0.241 *** 0.232 ***

(0.036) (0.041)

(0.071)

(0.044)

(0.044)

Size 0.015 -0.013

-0.013

-0.016

-0.013 **

(0.012) (0.015)

(0.029)

(0.016)

(0.016)

Lev -0.964 *** -0.901 *** -0.901 *** -0.908 *** -0.887 ***

(0.118) (0.118)

(0.219)

(0.127)

(0.127)

Nwc -0.405 *** -0.422 *** -0.422 ** -0.434 *** -0.410 ***

(0.111) (0.104)

(0.178)

(0.107)

(0.107)

Capex -0.327 * -0.280

-0.280

-0.269

-0.278

(0.187) (0.171)

(0.177)

(0.174)

(0.175)

Div 0.151 *** 0.111 *** 0.111 ** 0.113 *** 0.109 ***

(0.045) (0.042)

(0.055)

(0.041)

(0.041)

Cons -1.586 *** -0.770 ***

-0.561 ** -0.670 **

(0.207) (0.275)

(0.268)

(0.273)

R2 0.268 0.428

0.428

0.425

0.424

F-

pvalue 0.000

0.000

0.000

0.000

0.000

Dependent variable is corporate cash holding. Model 1 shows effect of corporate governance index on cash

holding, model 2 shows role of product market competition in the relationship of corporate governance and

cash holding. Model 3 shows effect of concentration on corporate governance and cash holding relationship.

Model 4 shows role of corporate governance on cash holding in family and non-family firms. Model 5 shows

role of Shariah compliance in corporate governance and cash holding relationship. All models are run with

time dummies, industry fixed effect, and standard error cluster with firm effect. First term in each cell shows

coefficient of variables and term in bracket shows standard error*, **, *** shows significance at 10%,5% and

1% respectively

.

The following subsections (4.1.1-4.1.5) discuss results of the five models presented in Table

4.2.

4.1.1 Corporate governance and Cash holding

The second column of Table 4.2 (i.e., Model 1) shows effect of corporate

governance score on level of cash holding and shows negative relationship of corporate

102

governance with cash holding. The result is interpreted as firms with good corporate

governance hold less cash. The result is supported by agency theory (Jensen, 1986) which

holds that high cash is expropriate by entrenched managers for their private benefit.

Therefore, agency problem leads to high level of cash and spending high cash on value

decreasing investments. The agency problem can be resolved through proper governance

which leads to low level of cash holding (Jensen, 1986). Moreover, negative effect of

corporate governance on cash holding is also supported by flexibility hypothesis. The

hypothesis claim that agency problem has positive relationship with cash holding because

high entrenched managers hold high cash to derive private benefit on the cost of minority

shareholders and tend to avoid external monitoring.

The empirical literature shows mixed result for relationship between firm level of

corporate governance and cash holding. For example, Harford et al. (2008) found that

corporate governance posits strong positive effect on cash holding. Similarly, Haung et al.,

(2013) used international data and found that high investor protection leads to high level of

cash holding. On the other hand, Kalcheva and Lins (2007) found insignificant effect of

corporate governance on cash holding. Our results are in line with Dittmar et al. (2003) who

used international data and found that companies hold less cash where investor protection is

weak as compared to the countries where investor protection is high. Our result is also

supported by Amman et al. (2011); Ozkan and Ozkan (2004); Kusnadi (2011) that firm level

corporate governance posits negative relationship with corporate cash holding. Keeping in

view the above results, H1a research hypothesis is accepted that corporate governance has

significant effect on corporate cash holding.

The control variables for model 1 have same predicted sign as expected. In line with

Harford et al. (2008) the result shows that cash flow and industry adjusted cash flow

volatility have positive and significant effect on cash holding. Furthermore, result of

103

dissertation shows that growth opportunity measured by market to book ratio has positive

significant relationship with level of cash holding and the result is supported by (Harford et

al., 2008; Cheng & Chaung, 2009; Kuan et al., 2011). The result indicates that firms that

having high growth opportunity hold high level of cash. Moreover, results indicate that

leverage is substitute to cash since it has negative relation with cash holding. The result is

supported by hierarchy theory that cash and leverage is substitute to each other and leverage

exerts negative effect on corporate cash holding. Similarly, net working capital and capital

expenditure also have negative relationship with cash holding as suggested by previous

studies (See for example, Cheng & Chaung, 2009; Harford et al., 2008; Kuan et al., 2011).

Furthermore, dividend has positive relationship with level of cash holding and indicates that

dividend paying companies hold high level of cash. These results are in line with Chieh-Tsai

(2012) who also shows positive relationship of dividend with corporate cash holding. The

value of R2 is 26.8%, means that cash holding is explained due to independent variables up

to 26.8%.

4.1.2 Effect of product market competition on the corporate governance and cash


The third column of Table 4.2 (i.e., Model 2) shows the effect of product market

competition on the relationship of corporate governance and cash holding. The result shows

that interaction of corporate governance index and competition dummy have negative and

significant effect on corporate cash holding. The result is supported by agency theory

(Jensen, 1986) that corporate governance has negative effect on corporate cash holding in

competitive industries. Firms operating in competitive industries and have good corporate

governance hold 0.523 less cash compare to firms operating in concentrated industries. In

line with Jain et al. (2013), result shows that firm level corporate governance exerts negative

effect on corporate cash in competitive industries compare to concentrated industries.

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Moreover, one of the queries of current research is to check whether corporate

governance has substitution effect for corporate governance in relationship with cash

holding. The result suggest that product market competition has substitution effect for

corporate governance in relationship with cash holding because sign of main variables i-e,

product market competition and corporate governance index is different from sign of

interaction term. Shen, Leng, and Wang (2015); Pattanayak (2010) suggests that if the sign

of main variables and interaction term is different it assumes substitution effect argument.

Substitution effect argument claims that product market competition work as

external market discipline which discourages managers to expropriate free cash flows for

their own interest even firm level governance is weak (Amman et al., 2013). External

market discipline put pressure on managers to work in best interest of shareholders even

firm level governance is weak compare to firms that are operating in concentrated industries

(Holmstrom, 1982; Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller, 2010;

Guadalupe & Perez-Gonzalez, 2010; Jain et al., 2013). Moreover, corporate governance is

more concerned in industries where competition is low because lack of external market

discipline to mitigate agency problem (Bena et al., 2017).

The researchers also show that strategic benefit of holding high cash exist in

concentrated industries compared to competitive industries because in concentrated

industries firms face difficulty to raise funds in capital market (Haushalter et al., 2007).

Moreover, in concentrated industries low cash may raise chance of under investment.

However, external market discipline is weak in concentrated industries and strong corporate

governance is needed to minimize the concern of shareholders about high cash holding in

concentrated industries (Jain et al., 2013). On the other hand, in competitive industries firms

have problem of over-investment because they make investment against their rivals and use

internal funds to create barriers for new entrants in the market. In competitive industry firms

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have shorter product life cycle and shareholders prefer low cash due to chance of over-

investment.

The relationship between corporate governance and cash holding in competitive

industries is also supported by flexibility hypothesis (Jensen, 1986) that corporate

governance has negative relationship with corporate cash holding in competitive industries.

On the basis of above discussion result of dissertation supported H1b hypothesis that

product market competition has substitution effect for corporate governance in relationship

with cash holding is accepted. The interaction of corporate governance index and product

market competition dummy is significant. The interaction term sign and the sign of main

variables i-e., corporate governance index and product market competition is different

which support substitution effect argument.

4.1.3 The effect of concentration on corporate governance and cash holding

relationship

The result of fourth column of table 4.2 (Model 3) shows the effect of corporate

governance on cash holding in concentrated industry. Governance index has positive but

insignificant effect on cash holding compared to model 1. The reason is that once interaction

term is included in regression the interpretation of main variables is different compared to

main variable used without interaction. Here the corporate governance index shows the

effect of omitted group that is competitive industry which takes value of zero and firms

belong to concentrated industries at particular year takes value of one. The interaction term

of corporate governance index and concentration shows positive relationship by 0.523. The

result indicates that difference between slope of governance index in concentrated industry

and slope of governance index in competitive industry. In line with Jain et al. (2013) the

result shows that in concentrated industry firms hold more cash as compare to firms in

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competitive industries. In concentrated industries the relationship between corporate

governance and cash holding is supported by spending hypothesis, that corporate

governance posits positive relationship with cash holding. The control variables including

market to book ratio, size, leverage, networking capital, capital expenditure, cash flow, cash

flow volatility and dividend are used on the precautionary motive of cash inspired from the

work of Opler et al. (1999); Harford et al. (2008); Jain et al. (2013). The control variables

have same sign as predicted and have same magnitude and significance level as model1 of

model 2 discussed in the preceding section (4.2.1).

4.1.4 Effect of corporate governance on cash holding in family and non-family firms

The result of column 5 of table 4.2 (Model 4) shows the effect of corporate

governance on cash holding in family firms using interaction term of governance index and

family firms dummy value of one for family firms and 0 for non-family firms. The essence

of this model is to investigate the effect of corporate governance on cash holding in family

owned firms because family owned firms have their unique organization structure compare

to non- family firms. The result shows that corporate governance has negative and

significant effect on cash holding in family firms. The result is supported in the context of

agency theory (Jensen, 1986) that family owned firms want to transfer their businesses from

one generation to another generation and want to make empire building for their family and

prefer high cash holding. Due to agency problem family owned firms are usually involved in

value destroying investment on the cost of minority investors (Kuan et al., 2011). In line

with these arguments, corporate governance shows negative relationship with cash holding

in family firms and limited the power of controlling shareholders.

Kalcheva and Lins (2007) found when investor protection are low, firms hold more

cash and interaction of percentage of managerial control and shareholder protection posits

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insignificant effect on cash holding using international data. The result of this dissertation

shows that corporate governance exerts negative effect on cash holding in family firms. The

result shows that family owned firms in Pakistan holds less cash by 0.346 when corporate

governance is improved in family owned firm as compared to non- family firm. Our result

are in line with Kuan et al. (2011) who also found negative effect of corporate governance

on cash holding in family owned firms.

The result is also supported by flexibility hypothesis (Jensen, 1986) that due to

agency problem family owned firms prefer high cash to expropriate for serving family

interest on empire building and value destroying over-investments on cost of minority

interest. Therefore, under good corporate governance shareholder prefer less cash in family

owned firms. In Pakistan Sheikh and khan (2015) found negative relation of board attributes

with corporate cash holding in family firms. Keeping in view these findings our research

hypothesis H1c is accepted that corporate governance has significant effect on cash holding

in family firms

The control variables including cash flow, cash flow volatility, leverage, networking

capital, capital expenditure and market to book ratio have same sign and significance level

as in column one and column two. The controlled variables sign is supported by

precautionary motive of cash.

4.1.5 The effect of corporate governance on cash holding in Shariah compliant firms

The last column (Model 5) of table 4.2 shows the effect of corporate governance on

cash holding in Shariah compliant firms. Shariah compliant firms have unique

organizational structure compared to non-Shariah compliant firms. Shariah compliant firms

must fulfill certain requirements to be considered as Shariah compliant firms’ i-e holding

liquid assets up to maximum 33%, holding debts up to maximum 37%, Investment only in

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halal businesses etc. The effect of corporate governance on cash holding in Shariah

compliant firms is explained in the context of agency theory. Shariah compliance resolve

agency problem due to its organization structure and substitute to corporate governance.

The result shows that effect of corporate governance on cash holding in Shariah

compliant firms is insignificant. The result is in line with Hayat and Hassan, (2017) found

that Shariah compliance does not promote corporate governance.

The result of this dissertation rejected hypotheses H1d that Shariah Compliance has

substitution effect for corporate governance in relationship with cash holding.

The control variables including cash flow, industry adjusted cash flow volatility,

leverage, networking capital, market to book ratio and industry adjusted capital expenditure

have the effect on corporate cash holding as per the prediction of precautionary cash motive

theory and have same sign and magnitude as model1.

4.1.6 Control of Endogeneity

This research found negative relationship of corporate governance and cash holding.

The simple OLS may be biased on the basis that normally corporate governance and cash

holding is jointly determined (Harford et al., 2008). To control endogeneity, 2SLS is

suggested in the literature. However, the problem is that 2SLS needs valid instrumental

variable but literature is normally silent about proper instrumental variables in corporate

governance and cash holding relationship (Harford et al., 2008). Therefore, to overcome this

problem, system GMM has been used to control endogeneity problem. The advantage of

system GMM is that it considers lag of dependent and independent variables as instrumental

variables. Therefore, there is no need to provide specific instrumental variables.

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Family ownership is endogenous choice between corporate governance and cash

holding. Family ownership is choice of corporate governance whereas, family ownership

and cash holding is jointly determined (Kuan et al., 2011). Furthermore, product market

competition is endogenous choice of corporate governance because competition is external

market discipline which acts as substitute for corporate governance. To control this problem

GMM model has been used. In the same way we also used GMM model to check the

relationship of corporate governance and cash holding in Shariah compliant firms.

Table 4.3 shows dynamic panel model for controlling endogeneity in the relationship

of corporate governance and cash holding. Furthermore, the role of product market

competition, family ownership and Shariah compliance is checked in the relationship of

corporate governance and cash holding. Model 1 shows effect of corporate governance

index on cash holding, model 2 shows role of product market competition in relationship of

corporate governance and cash holding. Product market competition is measured through

HHI index which is divided in tercile. The lowest tercile is assigned 1 which measured

competition and other wise 0. Model 3 shows role of corporate governance on cash holding

in family firms. Family ownership is measured through dummy variable with 1 for family

firms and 0 for non-family firms. Model 4 shows role of Shariah compliance on corporate

governance and cash holding relationship, which is measured as 1 for Shariah compliant

firms and 0 for non-Shariah compliant firms. Dependent variable is corporate cash holding

which is measured as ratio of cash holding to net asset. Each model has eight control

variables including: cash flow (cflow) , industry adjusted cash flow volatility (indcv),

market to book ratio (mtob), size of the firm (size), leverage of the firm (lev), net working

capital (nwc), capital expenditure (capex) and dividend (div).

110

Table 4.3: Dynamic panel model GMM effect of corporate governance on cash holding

model1 model2 model3 model4

casht-1 0.153 ** 0.154 ** 0.161 ** 0.157 **

(0.069) (0.069) (0.071) (0.070)

govind -0.186 * 0.145 -0.338 * -0.080

(0.106) (0.130) (0.173) (0.106)

comp*govind -0.383 **

(0.167)

comp

0.145 **

(0.067)

family

-0.467

(0.509)

family*govind

0.396 *

(0.210)

shariah

-0.038

(0.077)

shariah*govind

0.149

(0.180)

cflow 0.997 *** 1.009 *** 1.027 *** 0.999 ***

(0.244) (0.245) (0.248) (0.243)

indcv 0.180 *** 0.262 0.223 0.190

(0.047) (0.589) (0.589) (0.590)

mtob 0.180 *** 0.188 *** 0.172 *** 0.179 ***

(0.047) (0.046) (0.046) (0.047)

size 0.212 0.092 0.095 0.110 *

(0.588) (0.061) (0.061) (0.059)

lev -1.051 *** -0.990 *** -1.019 *** -1.048 ***

(0.263) (0.253) (0.262) (0.262)

nwc -1.092 *** -1.098 *** -1.101 *** -1.095 ***

(0.210) (0.211) (0.211) (0.209)

capex -0.388 *** -0.413 *** -0.396 *** -0.390 ***

(0.130) (0.132) (0.132) (0.130)

div -0.047 -0.039 -0.048 -0.050

(0.044) (0.043) (0.045) (0.044)

constant -2.691 *** -2.523 *** -2.123 *** -2.683 ***

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(0.929) (0.969) (1.112) (0.924)

wald chi2 0.000 0.000 0.000 0.000

AR2 p- value 0.172 0.845 0.945 0.988

Sargen p-chi2 0.770 0.095 0.102 0.129

Model 1 shows effect of corporate governance index on cash holding, while model 2 shows role of product

market competition on relationship of corporate governance and cash holding. Model 3 shows role of

corporate governance on cash holding in family and non-family firms. Model 4 shows role of Shariah

compliance on corporate governance and cash holding relationship. Dependent variable for each model is

corporate cash holding. Control variables include cflow (cash flow) , indcv (industry adjusted cash flow

volatility), mtob (market to book ratio), size, lev (leverage), nwc (net working capital), capex (capital

expenditure) and div (dividend). All models are run with time dummies and industry fixed effect and standard

error cluster with firm effect. *, **, *** shows significance at 10%,5% and 1%. First term shows coefficient of

variables and term in bracket shows standard error.

Table 4.3 shows the result of relationship between corporate governance index and

cash holding using system GMM and shows almost same result as table 4.2. Model 1 of

table 4.3 shows that corporate governance index have negative significant relationship with

corporate cash holding which is same as the result of corporate governance and cash holding

relationship of model 1 in table 4.2. The only difference is that corporate governance and

cash holding relationship is significant at 10% confidence level in table 4.3 compared to

table 4.2 where the relationship of corporate governance index and cash holding is

significant at 1%. However, the coefficient of corporate governance index is low in table 4.3

compared to table 4.2. Similarly, all control variables have almost same direction and

significance level. Furthermore, lagged cash holding is significant at 5% which indicates

that past cash holding predicted future cash holding.

The difference in the result of table 4.3 and table 4.2 is that industry adjusted cash

flow volatility is positive and significant in table 4.3, while it is insignificant in table 4.2.

The result of Wald test shows that overall model is significant at 1% confidence interval.

The result of Sargan test is insignificant which counts against the null hypothesis that there

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is no over identification problem. The result of AR2 is also insignificant and shows the auto

correlation is mitigated at lag 2.

The result of column 3 (Model 2) of table 4.3 shows the result of relationship

between corporate governance and cash holding in competitive industry using system

GMM. The result of interaction term of corporate governance index and product market

competition dummy posits negative relationship with cash holding that is similar to the

previous result in table 4.2. All control variables like cash flow, cash flow volatility,

leverage, networking capital, market to book ratio and capital expenditure have same sign

except dividend. Dividend has positive relationship with cash holding in table 4.2, while it

has negative relationship with cash holding in Table 4.3. This indicates that as dividend

increases firms hold less cash because when firm hoard high cash than mangers prefer to

utilize cash in form of dividend (Opler et al., 1999).

The result of column 4 (Model 3) of table 4.3 shows the effect of family ownership

on corporate governance and cash holding relationship using system GMM. The interaction

of family ownership and corporate governance posits different result between OLS and

system GMM. The table 4.2 indicates negative effect of corporate governance interaction

with family dummy on cash holding. On the contrary, the system GMM (table 4.3) indicates

that the interaction of corporate governance index and family ownership has positive

relationship with cash holding. The results of model 3 in GMM model are supported by

spending hypothesis and shareholder power hypothesis.

According to spending hypothesis firms utilize less cash in value destruction

investment under good governance and hoard high cash (Harford et al., 2008). Share holder

power hypothesis claims that minority investors allow firm to hold high cash as corporate

governance improves because they do not worry about firms to destroy free cash due to

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agency problem. Moreover, high cash will safeguard firm from under investment when firm

hold high cash. Similarly, according to share holder power hypothesis minority investors

willingly allow managers to hoard high cash when corporate governance is good. The result

is also in line with the work of Sheikh and khan (2015). Similarly, the result of lag cash

holding is positive and significant which indicates that past cash predict future cash holding.

Moreover, all controlled variables have same sign as presented in table 4.2.

Model four of table 4.3 shows the moderating role of Shariah compliance in the

relationship of corporate governance and cash holding using system GMM. The result is

same as table 4.2. The result shows that corporate governance index and Shariah

compliance interaction has insignificant relationship with corporate cash holding. Similarly,

all control variables have the same sign as in table 4.2 but the significance level is different.

4.2 Effect of corporate governance on Value of Cash holding


2b, 2c. Table 4.4 presents descriptive statistics of the data used for this purpose.

Table 4.4: Descriptive Statistics

full comp conc family

N-

family shariah

N-

shariah

ER -0.020 0.013 -0.079 0.011 -0.069 -0.007 -0.028

(0.491) (0.520) (0.429) (0.519) (0.440) (0.454) (0.513)

⊿CH 0.025 0.037 0.003 0.017 0.038 0.046 0.012

(0.425) (0.487) (0.281) (0.266) (0.599) (0.607) (0.253)

⊿Earning 0.035 0.064 -0.020 0.102 -0.074 -0.090 0.112

(6.375) (7.936) (0.816) (1.664) (10.111) (10.105) (1.612)

⊿NA 1.477 2.078 0.402 0.717 2.710 2.722 0.705

(18.088) (22.527) (1.622) (4.324) (28.747) (28.695) (4.315)

⊿INT 0.029 0.041 0.008 -0.014 0.098 0.086 -0.006

(1.097) (1.363) (0.163) (0.391) (1.704) (1.711) (0.364)

114

⊿D -0.007 -0.013 0.003 0.011 -0.037 -0.030 0.006

(1.805) (2.245) (0.255) (0.201) (2.913) (2.908) (0.199)

CHt-1 0.177 0.165 0.198 0.175 0.180 0.200 0.162

(0.423) (0.427) (0.417) (0.404) (0.454) (0.514) (0.353)

CHt-1*⊿CH -0.007 -0.002 -0.017 -0.017 0.008 0.006 -0.015

(0.669) (0.719) (0.571) (0.459) (0.911) (0.902) (0.459)

mktlev 0.602 0.643 0.528 0.663 0.503 0.336 0.649

(0.271) (0.266) (0.264) (0.246) (0.279) (0.262) (0.265)

mktlev*⊿CH 0.021 0.032 0.001 0.013 0.035 0.040 0.009

(0.406) (0.476) (0.230) (0.236) (0.584) (0.591) (0.224)

gov*⊿CH 0.000 0.001 -0.001 0.000 0.001 0.002 -0.001

(0.182) (0.164) (0.211) (0.196) (0.158) (0.172) (0.188)

gov 0.287 0.313 0.242 0.328 0.223 0.258 0.305

(0.453) (0.464) (0.429) (0.470) (0.417) (0.438) (0.461)

Second column shows descriptive statistics for full sample, column third shows competitive

industries, while column four shows concentrated industries. Column fifth shows family firms,

while column sixth shows non-family firms. Column seven shows Shariah compliant firms and

column eight shows non-Shariah compliant firms. ER shows excess return, ⊿CH shows change in

cash from t-1 to t and divided by lag market value of equity, ⊿Earning stands for change in earning

from t-1 to t and divided by lag market value of equity, ⊿NA stands for change net asset from t-1

to t and divided by lag market value of equity, ⊿INT shows change in interest from t-1 to t and

divided by market value of equity, ⊿D change in dividend from t-1 to t divided by lag market

value of equity, CHt-1 stands for lag cash divided by lag market value of equity and mktlev shows

market leverage which is calculated total debt divided by total debt +market value of equity

The result of table 4.4 shows descriptive statistics. The result indicates that average

excess return of full sample; concentrated industries; non-family firms; Shariah and non-

Shariah compliant firms are negative. On the contrary, average excess return is positive in

competitive industries and family firms .All independent variables are divided by lag market

value of firms following the methodology of Faulkender and Wang (2006); Dittmar and

Mahrt-Smith (2007); Jain et al (2013); Alimov (2014).

Change in cash is positive and stable in all cases. Change in earning is negative in

concentrated industries, non-family firms and Shariah compliant firms. Similarly, change in

115

net asset is less from 1 in concentrated, non- family and non Shariah firms. Lag cash is

stable in all sub samples, while market leverage is highest in family firms and lowest in


Table 4.5 shows effect of corporate governance on value of cash holding and the role

of product market competition, concentration, family ownership and Shariah compliance

respectively in the relationship of corporate governance and value of cash holding. The table

4.5 reports results of eight models. Dependent variable for each model is the excess return.

The first model shows determinants of value of cash holding and second model shows effect

of governance on value of cash holding. Third model shows effect of governance on value

of cash holding in competitive industries and fourth model shows effect of governance on

value of cash in concentrated industries. Fifth model shows effect of governance on value of

cash holding in family firms and sixth model shows effect of governance on value of cash

holding in non-family firms. Seventh model shows effect of good governance on value of

cash holding in Shariah compliant firms and last model shows effect of good governance on

value of cash holding in non- Shariah complaint firms. The results of these models are

discussed in the proceeding subsections (i.e., 4.2.1 to 4.2.8).

Table 4.5: Effect of Corporate Governance on Value of Cash Holding

Excess

return Full Full Comp Conc Family N-family Sharia N-sharia

⊿CH 0.655 ** 0.862 *** 0.962 ** 0.251 0.728 0.860 ** 0.511 0.478

(0.301) (0.302) (0.404) (0.473) (0.472) (0.432) (0.358) (0.598)

gov*⊿CH 0.570 *** 0.846 *** 0.333 0.809 *** 0.480 -0.246 1.040 ***

(0.138) (0.200) (0.198) (0.182) (0.322) (0.232) (0.211)

gov -0.053 -0.037 -0.104 ** -0.008 -0.149 *** -0.071 -0.026

(0.033) (0.043) (0.049) (0.042) (0.054) (0.049) (0.043)

⊿Earning 0.018 * 0.012 0.014 0.070 *** 0.028 ** 0.040 -0.013 0.028 **

(0.010) (0.010) (0.013) (0.024) (0.011) (0.046) (0.032) (0.012)

116

⊿NA 0.003 0.004 -0.005 -0.022 0.004 0.008 -0.017 * 0.006

(0.003) (0.003) (0.004) (0.015) (0.004) (0.011) (0.009) (0.005)

⊿INT -0.186 *** -0.181 *** -0.129 ** -0.528 *** -0.187 *** 0.078 0.069 -0.232 ***

(0.051) (0.051) (0.057) (0.152) (0.056) (0.171) (0.104) (0.060)

⊿D -0.107 ** -0.093 * 0.029 -0.068 0.182 * -0.279 0.250 0.191 *

(0.052) (0.052) (0.081) (0.104) (0.098) (0.234) (0.166) (0.104)

CHt-1 0.126 *** 0.124 *** 0.095 0.136 ** 0.128 * 0.149 0.090 0.160 ***

(0.045) (0.044) (0.071) (0.055) (0.050) (0.110) (0.073) (0.060)

CHt-1*⊿CH -0.054 0.049 -0.111 0.174 0.186 * 0.173 -0.226 0.260 ***

(0.051) (0.056) (0.094) (0.082) (0.076) (0.214) (0.180) (0.084)

mktlev 0.250 *** 0.265 *** 0.286 *** 0.231 *** 0.290 *** 0.158 * 0.360 *** 0.221 ***

(0.058) (0.058) (0.077) (0.085) (0.083) (0.083) (0.087) (0.079)

mktlev*⊿CH -0.714 ** -0.763 ** -0.647 -0.379 -0.578 -0.938 -0.255 -0.288

(0.363) (0.360) (0.480) (0.599) (0.529) (0.581) (0.443) (0.682)

cons -0.138 ** -0.124 ** -0.114 -0.109 -0.136 -0.099 -0.199 *** -0.068

(0.059) (0.059) (0.088) (0.070) (0.088) (0.075) (0.077) (0.085)

F-pvalue

0.000 0.000 0.000 0.000 0.002 0.001 0.000

R2

0.070 0.092 0.151 0.108 0.088 0.088 0.116

N

1137 729 405 702 435 290 550

Table4.5 shows effect of corporate governance on value of cash holding. Second column shows determinants of value of

cash holding, while third column shows effect of governance on value of cash holding. Fourth column shows effect of

governance on value of cash holding in competitive industries, while fifth column shows role of governance on value of

cash in concentrated industries. Sixth column shows role of governance on value of cash holding in family firms, while

seventh column shows role of governance on value of cash holding in non-family firms. Column eight shows role of

good governance on value of cash holding in Shariah compliant firms and last column shows role of good governance

on value of cash holding in non-Shariah complaint firms. The dependent variable is excess return which is calculated

using 25 Fama and French (1993) size and book to market ratio using monthly data from 2007 to 2014 and then

annualized and deducted from annual return of individual firm. Gov is a dummy variable measured through dividing

corporate governance index in terciles where highest tercile is assigned 1 and 0 is for the middle and lowest tercile.

Competition is measured through HHI index dividing in tercile with 1 for lowest tercile and 0 for middle and lowest

tercile. ⊿CH (change in cash), ⊿Earning (change in earning), ⊿NA (change in net asset), ⊿INT (change in interest), ⊿D

(change in dividend), and CHt-1 (lagged cash) are control variables. All control variables are divided by lag market

value of equity except market leverage. First term shows coefficient of variable and term in bracket is standard error. All

models are run with time dummies and industry fixed effect and standard error cluster firm level *, **, *** shows

significance at 10%, 5% and 1%.

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4.2.1 Determinates of value of cash holding

The second column of Table 4.5 shows result for the determinants of value of cash

holding following the work of Faulkender and Wang (2006); Dittmar and Mahrt-Smith

(2007). The result shows that change in cash has significant effect on value of shareholders

as suggested by Faulkender and Wang (2006). Similarly, change in earning and change in

net asset also have positive and significant effect on value of cash holding. On the other

hand, change in interest and change in dividend have significant negative affect on excess

return. .

The interaction term of lagged cash and change in cash is negative significant and

indicates that value of cash is high in firms with low level of cash compared to firms with

high level of cash. Similarly, the interaction term between market leverage and change in

cash is also negatively significant and indicates that market leverage decreases shareholder

value. Shareholders value cash less in firms with high debts because as leverage increases

extra cash is distributed among debt holders instead of shareholders. These results are in line

with the findings of Faulkender and Wang (2006) who also suggested negative significant

relationship of these interaction terms.

The results suggest that the value of cash to shareholders with firm having zero cash

and zero leverage is 0.655. The marginal value of cash to shareholders is 0.215 which is

found by adding the coefficient of change in cash plus coefficient of interaction terms

multiply by their respective mean values measured as (0.655+(-0.054*0.176)+(-.714*0.601).

The result shows that firms average cash contributes to the shareholders wealth by 0.215 for

1PKR extra investment.

118

4.2.2 Corporate governance and value of cash

The third column of table 4.5 addresses the issue whether corporate governance

effect value of cash? The result shows that the interaction term of governance and change in

cash is positive and significant. In the regression governance variable is dummy variable

with 1 for good governance and 0 for bad governance. The governance dummy variable is

created by dividing the governance index into terciles and assigning 1 for highest tercile and

0 for middle and lowest tercile. The positive sign of interaction term shows that shareholder

wealth increases in good governance firm by 0.570PKR as compared to the firms that have

bad governance. The result is supported by Dittmar and Mahrt-Smith (2007) who also found

similar result.

Similarly, the marginal value of cash holding under good governance is 0.982PKR

(which is measured as 0.862 + (0.049*0.176) + (-0.763*0.601) + 0.570) for one extra

Pakistani rupee, whereas it is 0.462 in firms having bad governance. The result is supported

by (Dittmar & Mahrt-Smith, 2007; Pinkowitz et al., 2006; Uddin, 2016) who also found

similar result. Value of cash to the shareholders is decrease by 0.570PKR due to bad

governance. The result is also supported by agency theory (Jensen, 1986) which suggests

that due to agency problem managers destroy excess cash of firm on value destroying

activities and ultimately decreases firm value. The result confirms the application of agency

theory that due to agency problem, firm value decreases and corporate governance increases

firm value. On the basis of above result H2a hypothesis of the research is supported that

corporate governance has significant and positive effect on value of cash holding and that

marginal value of cash holding is high in good governed firms compared to bad governed

firms.

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4.2.3 The effect of corporate governance on value of cash holding in competitive and


The present research also investigated that whether the relationship of corporate

governance and value of cash vary across different industries and ownership structures. To

answer this query we split our sample into firms that belong to competitive industries on

particular year and firms that belongs to concentrated industries respectively. The result

presented in column four and five shows that good governance has significant effect on

value of cash holding in competitive industries compared to concentrated industries. The

result shows that corporate governance dummy and change in cash interaction has positive

significant effect on value of cash holding in competitive industries. The result posits that

firms with good governance increases value of cash holding by 0.845PKR compared to

firms with bad governance in competitive industries. The marginal value of corporate

governance on value of cash holding in competitive industries is 1.37 measured as 0.962+(-

0.111*0.165)+(-0.647*0.642)+0.842. The result posits that shareholders wealth increases

more for extra 1PKR invested by shareholders.

In contrast, the effect of governance on value of cash holding is insignificant in

concentrated industries indicating that strong governance is comparatively more effective in

competitive industries than the concentrated industries. Effect of good governance dummy

and change in cash interaction on value of cash holding is insignificant in concentrated

industries. The marginal effect of governance on value of cash holding in concentrated

industries is 0.387PKR which is measured as (0.251+(0.0174*0.198)+(-

0.379*0.527)+0.333). The marginal effect of governance on value of cash holding in

competitive industries is comparatively 0.985-PKR higher than the effect of governance on

the value of cash holding in concentrated industries for extra 1PKR. The result is supported

by the work of Jain et al. (2013), they also found that the effect of good corporate

120

governance on value of cash holding is significant only in competitive industries compared

to concentrated industries.

Similarly, Alimov (2014) analyzed the effect of product market competition on value

of cash holding in good governance and bad governance firms and found insignificant

result. He claimed that product market competition has effect on value of cash holding but

the effect is insignificant for both good governance and bad governance firms. His finding

does not support agency theory. In contrast, Amman et al. (2011) supported substitution

effect argument and claimed that external market discipline substitute internal governance.

They found that strong corporate governance has insignificant effect on firm value in

competitive industries compare to concentrated industries. The difference of our study and

Amman et al (2011) study is that they measured firm value on Tobin Q and interacted

governance index and product market competition. This research adopted the methodology

of Faulkender and Wang (2006); Dittmar and Mahrt-Smith (2007) and measured firm value

through change in cash.

The substitution argument claims that even if company has weak governance

mangers are still forced by external market discipline to work in the best interest of

shareholders (Holmstrom, 1982; Nalebuff and Stiglitz, 1983; Hart, 1983; Giroud & Mueller,

2010, 2011; Guadalupe & Perez-Gonzalez, 2010). Similarly, Schoubben and Hulle (2013)

found that industry competition and industry concentration both have effect on value of cash

holding in weak governance firm. Moreover, industry competition and industry

concentration has insignificant effect on value of cash holding in strong governance firms.

The result of this research is supported by complementary hypothesis that corporate

governance has significant effect on value of cash holding in competitive industries

compared to concentrated industries. Complementary hypothesis claim that product market

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competition need efficient internal governance to reduce agency problem and ultimately

increase value of firm. In Pakistan competition commission of Pakistan work hard to ensure

healthy competition in the market but the size of registered industries is very low in Pakistan

stock exchange. On the basis of these facts Pakistan’s economy has only moderate level of

competition. Therefore, Pakistani companies need both external market discipline and good

internal governance to improve value of cash holding.

On the basis of results our H2b hypothesis is accepted that product market

competition has complementary effect for corporate governance in relationship with value

of cash holding.

4.2.4 The effect of corporate governance on value of cash holding in family and non-

family firms

The sixth and seventh column of table 4.5 indicates the effect of corporate

governance on value of cash holding in family and non-family firms respectively. The

extant research suggests two views on family controlled firm’s activities. The first view is

supported by stewardship theory and the second view is supported by agency theory.

According to stewardship hypothesis managers are steward of the company and despite of

agency problem managers of family control firm does not expropriate company free cash

and do not spend it on value destroying investments.

On the contrary, according to agency theory that family controlled firms serve the

interest of family instead of common shareholders and want to transfer business to next

generation (Kuan et al., 2011). The agency theory supports empire building hypothesis i.e.,

family firms want to make empire for their family members and for next generation. In

family firms due to high agency problem controlling family expropriate free cash and spend

it on value destroying investments which could serve the interest of family on the cost of

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minority shareholders (Yeh et al., 2001). Therefore, there is need of strong internal

governance to align interest of managers and shareholders to protect minority shareholders.

Boubaker et al., (2015) found that family control firms have negative effect on value

of cash because family control firms have high level of agency problem compare to non-

family firms. So, negative effect of family control on value of cash is altered by good

governance. In line with these views our result indicates that interaction term of good

governance dummy and change in cash is positively significant.

The result shows that change in cash under good governance in family firms add

firm value by 0.809PKR more than family firms with poor governance. The marginal value

of cash for family firms having good governance is 1.186. The result is interpreted in a way

that for one extra Pakistani rupee, good governance increases shareholder wealth by

1.186PKR in family firms. The result is supported by agency theory compare to stewardship

theory that due to agency problem controlling shareholders want to make empire for

particular family. Family firms want to fulfill their legacy and make value destroying

investment for their own benefit at cost of minority shareholders. Therefore, corporate

governance mitigate agency problem and result in increased firm value.

On the other hand, the result also shows effect of corporate governance on value of

cash holding in non-family firms. The interaction term of corporate governance dummy and

change in cash is insignificant. The result shows that cash does not add to firm value under

good governance in non-family firms. The marginal value for one extra Pakistani rupee in

non-family firm is 0.898 under good governance. The result shows that corporate

governance has a higher effect on value of cash holding in family firm compared to non-

family firms and the difference is 0.288. The result postulates that good governance

contributes to value of cash holding only in family firms compared to non-family firms.

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The result of this research accepted H2c hypotheses is that corporate governance

increases value of cash holding in family firms

4.2.5 Effect of corporate governance on value of cash holding in Shariah compliant and

non Shariah compliant firms

The last two column of Table 4.5 signify the effect of corporate governance on value

of cash holding in Shariah compliant firms and non- Shariah compliant firms respectively.

In Pakistan firms must fulfill certain criteria for inclusion in the list of Shariah compliant

firms. For example, their maximum short and long term debt to total asset should be 37%,

liquid assets should be at most 33% of their total assets. Similarly, the firm must have

generated less than 5% revenue from non-compliance investment. Moreover, their illiquid

assets to total assets ratio must be less than 25%. Jensen (1986) claimed that lower debt is

substitute for good governance. Since, Shariah compliant firms maintain lower debt (not

more than 37% of their total assets). Moreover, Shariah compliant firm have low liquid

asset up to maximum 33%. Therefore, keeping in the view of Jensen (1986) Shariah

compliance can be regarded as a substitute to good governance and due to Shariah

compliance agency problem is reduced. Moreover, recent article of Hayat and Hassan

(2017) also claims that Shariah compliance is alternative to good governance.

The result of this research posits that interaction of corporate governance and change

in cash shows insignificant effect on value of cash holding in Shariah compliant firms. This

result supports substitution base argument that Shariah compliance is alternative to good

governance that is why corporate governance has no role in Shariah compliant firms. On the

contrary, the result for non-Shariah compliant firm shows that corporate governance has

positive and significant effect on excess return and ultimately increases value of cash

holding. The marginal value is 0.9299 for one extra Pakistani rupee in non-Shariah firms

124

under good governance. The result posits that good governance increases value of cash

holding in non- Shariah compliant firm as compared to Shariah compliant firm. On the

basis of above discussion it is concluded that Shariah compliance is substitute to corporate

governance. Therefore H2d hypothesis is accepted that corporate governance has different

effect on value of cash holding in Shariah and non-Shariah compliant firms and Shariah

compliance is substitute to corporate governance in value of cash holding relationship.

4.3 Effect of corporate governance and excess cash on industry adjusted capital

expenditure


3b, 3c. The essence of this section is to investigate whether value of cash holding is

enhanced due to utilization of excess cash in the presence of corporate governance. This will

help in conceptualizing the role of corporate governance in the spending of excess cash on

value enhancing investment.

Following Harford et al. (2008); Amman et al. (2011); Jain et al. (2013) dissertation

considers utilization of excess cash in three ways including (change in industry adjusted

capital expenditure, dividend payments and diversification).

Table 4.6 shows the effect of corporate governance and excess cash interaction on

industry adjusted capital expenditure. Furthermore, table 4.6 shows effect of corporate

governance and excess cash interaction on industry adjusted capital expenditure in

competitive and concentrated industries; family and non-family firms; Shariah and non-

Shariah compliant firms. Table 4.6 reports results of seven models. Dependent variable for

each model is the change in industry adjusted capital expenditure. The first model shows the

role of corporate governance on excess cash and industry adjusted capital expenditure

relationship. Second and third model shows the role of corporate governance on excess cash

125

and industry adjusted capital expenditure relationship in competitive and concentrated

industries respectively. Similarly, model 4 and 5 signify the role of corporate governance on

excess cash and industry adjusted capital expenditure in family and non-family firms

respectively. The last two models investigate the role of corporate governance on excess

cash and industry adjusted capital expenditure in Shariah compliant and non-Shariah

complaint firms respectively.

Each model has six controlled variables including: cash flow (cflow), industry

adjusted cash flow volatility (indcv), leverage of the firm (lev), net working capital (nwc),

size of the firm (size), and market to book ratio (mtob).

The results of these models are discussed in the proceeding subsections.

Table 4.6: Role of corporate governance and utilization of excess cash on industry adjusted

capital expenditure (Dependent variable ⊿Ind-capex)

Full com conc family

Non-

family shariah

Non-

shariah

excesst-1 -0.004 * -0.005 *** -0.008 *** -0.007 *** -0.002 -0.006 ** -0.007 ***

(0.002) (0.002) (0.002) (0.002) (0.007) (0.002) (0.002)

excesst-

1*gov -0.109 -0.579 *** -0.129 -0.395 * -0.174 -0.189 -0.206 *

(0.189) (0.269) (0.165) (0.207) (0.319) (0.199) (0.115)

gov 0.017 0.008 0.064 *** 0.015 0.047 * 0.012 0.019

(0.012) (0.010) (0.023) (0.012) (0.027) (0.017) (0.012)

cflow -0.010 0.127 ** -0.084 0.020 0.051 -0.051 0.154

(0.050) (0.053) (0.064)

(0.071)

(0.136) (0.066)

(0.061)

indcv -0.249 *** 0.250 ** 0.220 ** 0.434 ** 0.033 0.197 * 0.274 **

(0.081) (0.109) (0.109) (0.137) (0.210) (0.114) (0.123)

lev -0.096 *** -0.075 ** -0.210 *** -0.154 *** -0.098 * -0.165 *** -0.113 **

(0.031) (0.033) (0.046) (0.043) (0.058) (0.042) (0.041)

nwc -0.064 ** -0.091 *** -0.146 *** -0.122 *** -0.050 -0.135 *** -0.109 ***

(0.026) (0.027) (0.030) (0.035) (0.083) (0.032) (0.026)

126

size 0.019 *** 0.017 *** 0.021 *** 0.020 *** 0.021 ** 0.017 *** 0.016 **

(0.004) (0.004) (0.004) (0.004) (0.007) (0.004) (0.005)

mtob -0.022 ** -0.010 0.037 *** 0.030 ** -0.049 0.007 0.002

(0.010) (0.010) (0.013) (0.013) (0.045) (0.013) (0.011)

cons 0.114 *** 0.112 *** 0.046 * 0.118 *** 0.100 ** 0.103 *** 0.078 ***

(0.025) (0.020) (0.026) (0.024) (0.040) (0.019) (0.038)

R-square 0.110 0.143 0.251 0.160 0.137 0.216 0.216

F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000

N 1350 870 477 836 514 290 550

The Second column shows role of corporate governance and excess cash on industry adjusted capital expenditure.

Third and fourth column shows role of corporate governance and excess cash on industry adjusted capital

expenditure in competitive industries and concentrated industries respectively. Similarly, the columns 5 to 8 show

the same phenomenon in family, non-family Shariah compliant, and non-Shariah compliant firms respectively.

Excess stands for lagged excess cash is independent variable Gov dummy is measured by dividing corporate

governance index in terciles on yearly basis with 1 for firms in the highest tercile and 0 for firms in the middle

and lowest tercile. Cflow stands for cash flow, while indcv stands for industry adjusted cash flow volatility, lev

stands for leverage, nwc stands for net working capital, size stands for size of the firm and mtob stands for market

to book ratio. All models are run with time dummies, industry fixed effect and standard error cluster with firm

level. First term is coefficient of variables and term in bracket shows standard error *, **, *** shows significance

at 10%, 5% and 10%.

4.3.1 Effect of excess cash on industry capital expenditure in good governance firms

The extant literature indicates that corporate governance play significant role on

utilization of excess cash which ultimately effect value of cash holding (See for example,

Harford et al., 2008; Jain et al., 2013). Following Harford et al. (2008); Amman et al.

(2011); Jain et al. (2013) dissertation considers utilization of excess cash in three ways

including: 1) change in industry adjusted capital expenditure 2) change in industry adjusted

dividend 3) diversification. .

Table 4.6 shows the effect of lag excess cash on change in industry adjusted capital

expenditure in good governance firm. The corporate governance is used as dummy variable

127

by dividing corporate governance into terciles. The highest tercile is assigned 1 and other

lowest and middle tercile assigned 0. On the other hand, excess cash is calculated as the

difference between actual and predicted cash. Residual cash is obtained from regression

from determinants of cash identified from work of Opler et al. (1999). The second column

of table 4.6 shows that the effect of interaction of lagged excess cash and corporate

governance is insignificant on industry adjusted capital expenditure in full sample. The

result shows that good governance has no role on utilization of excess cash in form of

industry adjusted capital expenditure. The result of dissertation does not support agency

theory that suggests that corporate governance leads to efficient utilization of excess cash.

Harford et al., (2008) found positive effect of lag excess cash on industry adjusted capital in

good governance firms and found insignificant effect of lag excess cash on industry adjusted

capital expenditure under bad governance. In contrast Jain et al., (2013) found negative

relation between lag excess cash and industry adjusted capital expenditure under good

governance.

The control variable cash flow which has insignificant effect on industry adjusted

capital expenditure. Similarly, the industry adjusted cash flow volatility has negative and

insignificant effect on industry adjusted capital expenditure. The result is supported by

precautionary cash motive which suggests that as cash volatility increases firms maintain

high cash to buffer against external shocks. Moreover, companies whose cash flow volatility

is higher than the industry median make less internal investment compared to their

respective industry. The marginal effect is that one unit increase in cash flow volatility

decreases industry adjusted capital expenditure by 0.249.

Similarly, leverage has significant negative relationship with industry adjusted

capital expenditure (capex), one unit increase in leverage decreases industry capital

expenditure by 0.096. So, the result shows that as debt increases, firm will repay interest and

128

principal on time and if company is unable to repay, chances of bankruptcy may be arise.

Therefore, when debt increases firms does not prefer spending of excess cash in the form of

industry adjusted capex. Harford et al., (2008) also shows negative but insignificant

relationship of leverage with industry adjusted capex. Moreover, net working capital also

shows negative and insignificant relationship with industry adjusted capex. This result is in

line with Jain et al. (2013) who also found negative relationship of networking capital with

industry adjusted capex.

On the other hand, size of the company shows positive and significant relationship

with industry adjusted capex. In line with Jain et al. (2013) the result shows that large

companies have high capex compared to industry average other things remain constant.

Similarly, market to book ratio which is an indicator of growth opportunity shows that

companies that have high growth opportunities in future make less investment in form of

capex compared to their respective industry in which they operate.

The proceeding sections investigate whether the role of corporate governance in

utilization of excess cash in the form of industry adjusted change in capex is same or

different across different industries and firms ownerships. Section 4.3.2 considers

competitive and concentrated industries, section 4.3.3 considers family and non-family firms

while, section 4.3.4 considers Shariah compliant and non-Shariah compliant firms.

4.3.2 Effect of corporate governance on excess cash and industry adjusted capital

expenditure relationship in competitive and concentrated industries

The result in column 3 and column 4 shows utilization of lagged excess cash in the

form of industry adjusted change in capex under corporate governance in competitive and

concentrated industries. The result shows that the interaction of lagged excess cash with

good governance has significant negative effect on industry adjusted capex in competitive

129

industries. The result portray that in presence of good governance, excess cash is relatively

less utilized on capex in competitive industry. In contrast, corporate governance has no role

in utilization of excess cash in form of capex in concentrated industries. Jain et al. (2013)

found negative but insignificant effect of excess cash utilization in form of capex in firms

from competitive and concentrated industries. The results of this research supported

complementary hypothesis that product market competition still needs good governance to

reduce agency problem and efficient utilize excess cash.


expenditure relationship in family and non-family firms

The result of column 5 and 6 in table 4.6 posits the role of governance on utilization

of excess cash in form of capital expenditure (capex) in family and non-family firms.

Research shows that family owned firms have high agency problem therefore, controlling

shareholders of family firm’s waste excess cash in value destroying investments. Hence,

there is need of proper governance in mitigation of agency problem and efficient utilization

of excess cash. In line with this view the result posits that lagged excess cash and

governance dummy has negative and significant effect on industry adjusted change in capex

in family firms. The coefficient of interaction term shows that well governed family owned

firms spend 0.395 less money on industry adjusted capex compare to the poorly governed

family firms.

The controlled variables have almost same signs and significance level as indicated

in first column except cash flow. That is leverage, networking capital and market to book

ratio has negative relationship with industry adjusted capex. Similarly, size and industry

adjusted cash flow volatility has positive and significant relationship with industry adjusted

capex. However, cash flow is positively significant, while it is insignificant in first column.

130

The result of column 6 shows insignificant effect of interaction term of lag excess

cash with corporate governance dummy on industry adjusted change capital expenditure.

This means that governance has no role in utilization of excess cash in form of capex in non-

family firms. The result posits that agency problem is high in family firms compared to non-

family firms and good governance play significant role in family firms to control agency

problem between controlling shareholders and minority shareholders.


expenditure relationship in Shariah compliant and non-Shariah compliant firms

This section investigates the role of corporate governance in utilization of excess

cash in form of capital expenditure (capex) in Shariah and non- Shariah labeled firms. The

result in column 7 shows that interaction term of corporate governance dummy and lag

excess cash has negative but insignificant relationship with industry adjusted change in

capex. The result shows that coefficient of excess cash is negative and significant which

indicates that Shariah compliance leads to efficient utilization of excess cash in poor

governance firms because the effect of omitted group is capture in main variable i-e., excess

cash. Therefore, we can conclude that Shariah compliance is substitute to good governance

as suggested by Hayat and Hassan (2017).

On the other hand, the result of interaction term of corporate governance and lag

excess cash shows significant negative relationship with industry change capex in non-

Shariah compliant firms. The result is interpreted in way that good governance work better

in non-Shariah compliant firms as compare to Shariah compliant firms in resolving agency

problem. The result of column 8 posits that excess cash is 0.229 utilize less in non-Shariah

compliance firm in form of industry change in capex under good governance as compare to

poor governance firms.

131

The control variables including cash flow and market to book ratio shows

insignificant relationship with industry change capex, while industry adjusted cash flow

volatility, leverage and networking capital have significant effect on industry change in

capital expenditure (capex).

4.4 Effect of corporate governance on excess cash and dividend relationship

As discussed earlier, this dissertation considers utilization of excess cash in three

ways following Harford et al. (2008); Amman et al. (2011); Jain et al. (2013) including: 1)

change in industry adjusted capital expenditure 2) dividend payments 3) diversification.

This section considers the utilization of excess cash for dividend payments. Table 4.7 shows

the effect of corporate governance on utilization of excess cash in form of dividend, and the

role of product market competition, family ownership, and Shariah compliance respectively

in this relationship. The Table 4.6 reports results of seven models. Dependent variable for

each model is dividend which is measured 1 for dividend paying firms and 0 for non-paying

firms. The first model shows the role of corporate governance on excess cash and dividend

payout relationship. Second and third model shows the role of corporate governance on

excess cash and dividend payout relationship in competitive and concentrated industries

respectively. Similarly, model 4 and 5 signify the effect of corporate governance on excess

cash and dividend payout relationship in family and non-family firms respectively. The last

two models investigate the joint effect of corporate governance and excess cash on dividend

in Shariah compliant and non-Shariah complaint firms respectively.



size of the firm (size), and market to book ratio (mtob). The results of these models are

discussed in the proceeding subsections.

132

Table 4.7: Role of corporate governance on excess cash and dividend relationship

div full com conc family

N-

family sharia

N-

sharia

excesst-1 0.064 0.127 *** 0.208 *** 0.159 *** -0.120 * 0.371 *** 0.062

(0.050) (0.033) (0.046) (0.035) (0.062) (0.139) (0.050)

excesst-

1*gov 0.138 *** 0.045 0.191 ** 0.056 0.294 *** 0.227 0.132 ***

(0.024) (0.054) (0.090) (0.056) (0.090) (0.222) (0.027)

gov -0.157 -0.186 -0.201 -0.264 ** -0.042 -0.304 -0.179 *

(0.101) (0.120) (0.223) (0.118) (0.259) (0.435) (0.108)

cflow 0.018 * 0.025 0.011 0.014 * 0.601 *** 0.035 ** 0.026

(0.010) (0.020) (0.008) (0.008) (0.078) (0.016) (0.022)

indcv -0.036 ** -0.131 *** -0.023 -0.114 *** 0.000 -0.116 -0.034 **

(0.015) (0.025) (0.016) (0.025) (0.014) (0.104) (0.016)

lev -0.003 -0.003 0.005 -0.012 ** 0.018 ** -0.091 0.002

(0.004) (0.006) (0.007) (0.006) (0.008) (0.084) (0.004)

nwc 0.097 *** 0.083 *** 0.179 *** 0.132 *** 0.083 *** 0.095 0.102 ***

(0.022) (0.027) (0.034) (0.028) (0.024) (0.102) (0.024)

size 0.002 0.009 ** 0.000 0.002 0.025 *** 0.021 0.002

(0.002) (0.004) (0.003) (0.003) (0.008) (0.016) (0.002)

mtob 0.004 0.026 * -0.017 0.016 0.043 *** 0.177 ** 0.002

(0.006) (0.014) (0.025) (0.017) (0.008) (0.087) (0.006)

cons 0.942 *** 0.744 *** 1.139* 1.112 0.920 0.813 1.044

(0.297) (0.377) (0.604) (0.507) (0.439) (0.759) (0.359)

F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000

Pseudo R2 0.210 0.224 0.276 0.213 0.459 0.510 0.210

Second column of Table 4.6 shows role of corporate governance on excess cash and dividend relationship.

Third column shows role of corporate governance on excess cash on dividend relationship in competitive

industries. Fourth column shows the same phenomenon in concentrated industries. Fifth column considers

family firms, while sixth column considers non-family firms Seventh column eight shows Shariah compliant

firms and eighth column considers non-Shariah compliant firms. Dependent variable is dividend which is

dummy variable with 1 for firms that pay dividend and 0 for firms that do not pay dividend in a particular

year. Independent variable is lagged excess cash interected with governance dummy. Cflow stands for cash

flow, while indcv stands for industry adjusted cash flow volatility. Lev stands for leverage, while nwc stands

for net working capital. Size stands for size of the firm and mtob stands for market to book ratio. All models

are run with probit model .First term is coefficient of variables and term in bracket shows standard

error.*,**,*** shows significance at 10%,5% and 10%.

133

4.4.1 Effect of excess cash with good governance on dividend

Table 4.7 shows utilization of excess cash in form of dividend. The result shows that

interaction term of lagged excess cash with corporate governance dummy shows positive

and significant effect on dividend. This result is supported by flexibility hypothesis (Jensen,

1986) that firms with strong level of governance hold less cash. Shareholders under good

governance prefer excess cash distribution in form of dividend. Moreover, under strong

corporate governance, minority shareholders pressurize firm management to distribute

excess cash in the form of dividend. The result is in line with Laporta et al. (2000) who also

found that corporate governance has positive relationship with dividend payout. Moreover,

they suggested that dividend payment is high in countries where investor’s protection is

high. Similarly, agency theory (Jensen, 1986) claims that dividend payment protects

minority shareholders from the exploitation of majority shareholders when agency problem

is high. Therefore, dividend payment is tool to resolve agency problem and free cash flow

problem. Harford et al. (2008) found that excess cash has positive significant effect with

industry change in dividend in poor governance firms. Their result supports spending

hypothesis that firm with governance dissipate excess cash quickly.

The substitution model and outcome model also explain the role of dividend.

According to substitution model dividend payment is high in companies where internal

governance is weak and dividend is substitute for governance to resolve conflict between

shareholders and mangers (Amina, 2015). In contrast, outcome model claims that dividend

payment is high in companies or countries where internal governance is strong and investors

are highly protected. Our result is in line with outcome model that excess cash with strong

governance increase dividend. Furthermore, Amman et al. (2013) found that dividend

134

increases firm value in good governance firms. Our result is also in line with Kowalewski et

al. (2007) who also found that dividend is high in good governed firms compare to poor

governed firms.

4.4.2 Utilization of excess cash in the form of dividend under good governance in

competitive and concentrated industries

Column 3 & 4 signify the utilization of excess cash in the form of dividend under

strong governance in competitive industries and concentrated industries respectively. The

result shows that interaction term of lagged excess cash and governance dummy shows

insignificant effect on dividend in competitive industries. The result postulated that in

competitive industries shareholders trust the company to hold cash and pay fewer dividends.

These results support substitution effect argument of product market competition for

corporate governance in the utilization of excess cash in form of dividend. The agency

problem is resolved by external market discipline and don’t need internal governance. The

result posits that good governance has no role in utilization of excess cash in competitive

industries. In contrast, interaction of governance dummy and lagged excess cash has

positive significant effect on dividend in concentrated industries.

Good governance work well in utilization of excess cash in concentrated industries

compared to competitive industries in form of dividend. This result is also supported by

substitution based argument that for efficient utilization of excess cash and control of

agency problem, efficient internal governance is needed in concentrated because lack of

external market discipline.

135


family and non-family firms.

The research also investigates utilization of excess cash under strong corporate

governance in family and non-family firms. Result of column 5 & 6 of table 4.7 shows

utilization of excess cash in form of dividend in family and non-family firms respectively

under strong governance. The result of interaction between corporate governance dummy

and lagged excess cash shows insignificant effect on dividend in family firms. Family firms

have insignificant difference in the utilization of excess cash under good and poor

governance. The result here supported by argument that shareholders value less dividend

payments in the firms with good governance. The shareholders of family firms have

confidence that excess cash will not be expropriated by managers and big shareholders due

to strong internal governance of the firm. The result is also supported by dividend

substitution model that dividend is substitute for corporate governance to control agency

problem.

The control variables including cash flow and net working capital show positive and

significant relationship with dividend. On the other hand, cash flow volatility and leverage

shows significant and negative relationship with dividend, while market to book ratio and

size shows insignificant relationship with dividend. Our result is different from Wei, Wu,

and Chen (2011) who found that family ownership has negative relationship with dividend

and this relationship altered (i.e., becomes positive) when family ownership is interacted

with institutional ownership. Our result is different form Wei et al. (2011) because we have

considered family and non-family firms. Moreover, our interaction term is different from

interaction term of Wei et al. (2011).

136

Column 6 of table 4.7 shows the effect of utilization of cash in non-family firms with

good corporate governance. The result shows that interaction of lagged excess cash with

corporate governance dummy shows positive significant relationship with dividend in non-

family firms. The result posits that utilization of excess cash in form of dividend under good

governance is 0.293PKR more in non-family firm compared to non-family firms with poor

governance. The result posits that shareholders prefer dividend in non-family firms when the

governance is strong. This result is supported by outcome model instead of substitution

model. Therefore, on the basis of these results we conclude that utilization of excess cash in

the form of dividend under good corporate governance is higher in non-family firms

compared to family firms.


Shariah compliant and non- Shariah compliant firms

Column 7 and 8 of table 4.7 shows utilization of excess cash in Shariah compliant

and non- Shariah compliant firms under strong corporate governance. The result of column

7 shows interaction of lagged excess cash and corporate governance dummy has

insignificant effect on dividend in Shariah compliant firm. This result is support by

substitution model of dividend that Shariah compliance is substitute to good governance

(Hayat & Hassan, 2017; Ullah & Rizwan, 2018). Therefore, Shariah compliance is enough

to control agency problem alone and internal corporate governance has not much

importance in controlling agency problem for efficient utilization of excess cash.

Moreover, in Shariah compliant firms low agency problem exist that’s why

shareholders value dividend less in Shariah compliant firms. Another interpretation is that

Shariah compliant firms have low free cash flow problem compared to non-Shariah

compliant firms (Hayat & Hassan, 2017). That’s why shareholders do not worry about

137

expropriation of firm excess cash by large shareholders and entrenched management. Excess

cash alone is significant positively means that Shariah compliant firms increase dividend

under poor internal governance.

On the other hand, the result of column 8 shows that interaction of lagged excess

cash and corporate governance dummy have positive and significant effect on dividend in

non-Shariah compliant firms. The result is again supported by agency theory (Jensen, 1986)

that entrenched manages prefer distribution of excess cash in form of dividend. This

indicates that shareholders prefer excess cash to be distributed among shareholders in the

form of dividend when firm governance is strong and agency problem is minimized due to

dividend payment. The interaction term shows difference of utilization of excess cash in the

form of dividend under good and poor governance in non-Shariah compliant firms.

Dividend outcome model is applicable in non-Shariah compliant firms because these firms

has high debt and the chances of bankruptcy is higher in non- Shariah compliant firms

compare to Shariah compliant firms.

4.4.5 Effect of corporate governance on excess cash and corporate diversification

relationship

Diversification is important strategy for company. Economist finds out negative

relationship of corporate diversification and firm value (e.g., Lang & Stulz 1994; Berger &

Ofek, 1995). The negative relationship was justified on the basis of agency theory.

Whenever, firms have high agency problem they involve in unrelated diversification. The

essence of this section is to investigate whether value of cash holding is enhanced due to

utilization of excess cash on diversification in the presence of strong corporate governance.

This will help in conceptualizing the role of corporate governance in the spending of excess

cash on value enhancing diversification.

138

Table 4.8 shows the role of corporate governance on spending of excess cash in form

of diversification. The dissertation also checked the role of corporate governance on

spending of excess cash in form of diversification in competitive and concentrated

industries; family and non-family firms; Shariah and non-Shariah compliant firms. Table

4.8 reports the results of seven models. Dependent variable for each model is diversification

measured as 1 for diversified firm and 0 fir stand-alone firms. The first model shows the role

of corporate governance on spending of excess cash in form of diversification. Second and

third model show the role of corporate governance on spending of excess cash in form of

diversification in competitive and concentrated industries respectively. Similarly, model 4

and 5 signify the role of corporate governance on spending of excess cash in form of

diversification in family and non-family firms respectively. The last two models investigate

the role of corporate governance on excess cash and diversification relationship in Shariah

compliant and non-Shariah complaint firms respectively.



size of the firm (size), and market to book ratio (mtob).

The results of these models are discussed in the proceeding subsections.

Table 4.8: Role of corporate governance on spending of excess cash in form of diversification

(dependent variable diversification)

Diversification full com conc family

N-

family sharia

N-

sharia

excesst-1*gov -0.067 ** -0.068 ** -0.046 -0.126 *** 0.005 0.043 -0.073 **

(0.028) (0.034) (0.059) (0.037) (0.052) (0.134) (0.029)

excesst-1 0.074 *** 0.100 *** 0.050 ** 0.111 *** 0.037 -0.063 0.079 ***

(0.016) (0.023) (0.024) (0.022) (0.040) (0.090) (0.017)

gov -0.374 *** -0.371 *** -0.725 *** -0.744 *** -0.193 -0.847 ** -0.390 ***

(0.087) (0.109) (0.166) (0.111) (0.177) (0.331) (0.092)

139

cflow -0.001 0.001 -0.004 0.002 0.027 -0.009 0.002

(0.005) (0.007) (0.006) (0.005) (0.024) (0.007) (0.007)

indcv -0.027 *** -0.020 -0.041 -0.008 -0.118 *** -0.005 -0.029 ***

(0.010) (0.014) (0.027) (0.018) (0.035) (0.084)

(0.010)

lev 0.006 0.007 0.010 * 0.010 0.007 -0.033 *** 0.010 **

(0.004) (0.006) (0.006) (0.010) (0.005) (0.009) (0.004)

nwc -0.032 *** -0.032 ** -0.022 -0.047 ** -0.030 ** -0.308 *** -0.021 **

(0.010) (0.013) (0.015) (0.019) (0.013) (0.062) (0.010)

mtob -0.057 *** -0.093 *** -0.007 -0.070 *** -0.032 -0.147 * -0.054 ***

(0.014) (0.019) (0.022) (0.018) (0.026) (0.085) (0.014)

size 0.005 *** 0.005 * 0.004 ** 0.029 *** -0.005 ** -0.007 0.005 ***

(0.002) (0.003) (0.002) (0.006) (0.003) (0.015) (0.002)

cons 0.367 *** 0.460 *** 0.216 *** 0.840 *** -0.048 1.196 *** 0.355 ***

(0.043) (0.059) (0.068) (0.068) (0.064) (0.200) (0.046)

Prob > chi2 0.000 0.000 0.000 0.000 0.003 0.000 0.000

Pseudo R2 0.047 0.061 0.062 0.141 0.045 0.340 0.045

N 1350 870 475 834 514 290 550

Table 4.7 shows role of corporate governance on excess cash and diversification. Second column shows role of corporate

governance on excess cash and industry adjusted capital expenditure in competitive industries, third column considers

concentrated industries, fifth column considers family firms, seventh column considers non-family firms, eight column

considers Shariah compliant firms and column 10 shows non-Shariah compliant firms. Dependent variable is diversification

which is a dummy variable with 1 for diversified and 0 for non-diversified firms. Independent variable is lagged excess cash

which is residual of determinant of cash holding and moderating variable is gov dummy which is measured by dividing

corporate governance index in terciles on yearly basis with 1 for firms in highest tercile and 0 for firms in middle and lowest

tercile.. All models are run with probit model. First term is coefficient of variables and term in bracket shows standard

error.*,**,*** shows significance at 10%, 5% and 10%.

Column 2 of table 4.8 posits the result about utilization of excess cash on

diversification under strong governance that further effects firm value. The result shows that

interaction of lagged excess cash and corporate governance dummy shows negative and

significant relationship with corporate diversification. The result shows that the coefficient

of interaction term is -0.066 which shows that 0.066 PKR less excess cash is spent by well

governed firms on diversification compared to poorly governed firms. Agency theory

140

provides possible explanation for firms involve in diversification. For example, Jensen

(1986) claimed that when excess cash increases mangers can use it at their discretion to

increase diversification. So, due to agency problem firms invest excess cash on

diversification. Amihud and Lev (1981) found that mangers involve in diversification to

decrease their own level of risk instead of overall firm risk is because due to agency

problem. Similarly, Chen and Steirner (2000) found the same result which is in support of

agency theory that firms due to agency problem channel their discretionary cash flows

towards diversification. Therefore, diversified firms face high agency cost as compared to

stand-alone firms (Rajan et al., 2000; Subramaniam et al., 2013). On the basis of this

discussion we conclude that good corporate governance reduces spending of excess cash on

diversification.

In line with Chen and Steiner (2000) the coefficient of excess cash shows positive

and significant relationship with diversification shows that poor governed firms’ increases

channelizing excess cash towards diversification. These results are supported by agency

theory (Jensen, 1986) i.e., due to agency problem managers spend excess cash on

diversification that benefit managers to lower their risk instead of overall firm and internal

good governance is needed to resolve agency problem.

The other control variables like cash flow and leverage shows insignificant

relationship with diversification, while industry adjusted cash flow volatility shows negative

and significant relationship with diversification. Similarly, market to book ratio also shows

negative relationship with diversification.

Column 3 and 4 of table 4.8 shows effect of excess cash under good governance on

diversification in competitive and concentrated industries. The result of column 3 shows that

interaction between lagged excess cash and corporate governance dummy shows negative

141

effect on diversification in competitive industries. There are two different points of view

about corporate governance and product market competition relationship i-e., substitution

effect and complementary effect. The result shows that competitive industry need good

governance for efficient utilization of excess cash. This result is supported by the

complementary hypothesis because external market discipline needs strong internal

governance. In competitive industries companies goes toward diversification compared to

concentrated industries because in competitive industries companies want to take

competitive edge. On the other hand, the result of column 4 of table 4.8 shows that corporate

governance has insignificant effect on utilization of excess cash in form of diversification in

concentrated industries. The result is supported by complementary effect argument that for

efficient utilization of excess cash, strong internal governance and external market discipline

both are needed, and in concentrated industries external market discipline is weak.

Furthermore, column 5 and 6 of table 4.8 shows effect of excess cash on

diversification under good governance in family firms and non-family firms. The result of

interaction between lagged excess cash and corporate governance dummy shows negative

and significant relationship with diversification in family firms. The coefficient value of

interaction term is -0.126 indicating that spending of excess cash on diversification under

good governance in family firms is less than spending of excess cash on diversification

under poor governance in family firms. Family firms generally have high agency problem

compared to non-family firms (Lien and Li., 2013). The family firms involve in

diversification under empire building hypothesis i.e., due to diversification family firms

want to create empire for particular family. Furthermore, family members want to transfer

business to next generation that’s why family businesses channel excess cash towards

diversification (Lien & Li., 2013). Column 6 in table 4.8 shows that interaction of lagged

142

excess cash with corporate governance firms in non-family firms and result posits that

interaction term has insignificant effect on diversification.

Column 7 and column 8 of table 4.8 show effect of utilization of excess cash under

good governance in Shariah compliant and non-Shariah compliant firms. The result shows

that interaction term between lagged excess cash and good governance dummy posits

insignificant effect on diversification in Shariah compliant firms. This is because Shariah

compliance is substitute to good governance. Therefore, good governance does not affect

utilization of excess cash significantly in Shariah compliant firm. On the other hand, the

interaction of lagged excess cash with good governance dummy posits significant negative

effect on diversification. The coefficient value of interaction term is -0.073 which indicates

that non-Shariah compliant firms spend 0.073 less on diversification under good governance

compared to the similar firms under poor governance.

Keeping in view the results of Table 4.6, Table 4.7, and Table 4.8 it can be

concluded that corporate governance has significant role on utilization of excess cash.

Therefore, the hypothesis H3a is accepted. Similarly, the role of corporate governance in

the utilization of excess cash is significant in competitive industries compared to

concentrated industries; therefore hypothesis H3b is accepted that corporate governance

has significant role on utilization of excess cash in competitive industries

Moreover, the result supported H3c hypothesis that corporate governance has

significant effect on utilization of excess cash in family firms. Similarly, the result also

supports H3d hypothesis that corporate governance has insignificant effect on utilization of

excess cash in Shariah compliant firms and shows that corporate governance has significant

different effect on utilization of excess cash in Shariah and non-Shariah compliant firms.

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4.5 Role of product market competition, family ownership and Shariah compliance on

utilization of excess cash

For robustness table 4.9 shows role of product market competition, family ownership

and Shariah compliance in utilization of excess cash. Column 2-4 consider utilization of

excess cash in competitive industries, column 5-7 consider the same phenomenon in

Shariah compliant firms, while column 8-10 consider family owned firms.

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Table 4.9: Role of competition, family ownership and Shariah on spending of excess cash

⊿Indcapex Div diver indchgcapex div diver ⊿Indcapex div diver

cflow 0.104 * 0.018*** 0.831 0.011 0.018 *** -0.001 0.115 ** 0.017 *** 0.002

(0.058) (0.005) (0.512) (0.052) (0.005) (0.006) (0.045) (0.005) (0.006)

indcv 0.339 *** -0.037*** -0.035** 0.254 *** -0.036 *** -0.040 ** 0.293 *** -0.037 *** -0.028 *

(0.089) (0.009) (0.015) (0.081) (0.009) (0.016) (0.060) (0.010) (0.015)

lev -0.181 *** -0.004 0.007* -0.103 *** -0.004 0.008 * -0.154 *** -0.003 0.003

(0.034) (0.005) (0.004) (0.032) (0.005) (0.004) (0.038) (0.005) (0.004)

nwc -0.142 *** 0.103*** -0.007 -0.078 *** 0.097 *** -0.006 -0.148 *** 0.106 *** 0.003

(0.035) (0.012) (0.011) (0.026) (0.013) (0.011) (0.030) (0.013) (0.010)

mtob 0.010 0.004 -0.040*** -0.018 * 0.006 -0.038 *** 0.018 0.001 -0.032 **

(0.024) (0.007) (0.014) (0.010)

(0.008) (0.014)

(0.018) (0.008) (0.014)

size 0.022 *** 0.002 0.005*** 0.019 *** 0.002 0.005 *** 0.017*** 0.003 * 0.005 ***

(0.004) (0.001) (0.001) (0.004) (0.001) (0.001) (0.003) (0.002) (0.001)

excesscasht-1 -0.003 0.187*** 0.112*** -0.004 ** 0.145 *** 0.103 *** -0.004** 0.252 *** -0.463

(0.003) (0.029) (0.021) (0.002) (0.020) (0.019) (0.002) (0.041) (1.067)

excesscasht-1*comp -0.970 *** -0.047 -0.873***

(0.309) (0.032) (0.306)

comp 0.079 *** 0.179 0.278

(0.020) (0.176) (0.184)

145

⊿Indcapex Div diver indchgcapex div diver ⊿Indcapex div diver

Sharia

-0.247 * 0.012 2.613 *

(0.142) (0.031) (1.334)

excesscasht-1*shariah

0.016 0.221 ** -0.340 ***

(0.013) (0.101) (0.127)

excesscasht-1*family

0.062 *** -0.111 *** 0.090 ***

(0.013) (0.042) (0.021)

family

-0.615*** 0.195 * 0.741 ***

(0.161) (0.111) (0.102)

_cons 0.100 *** 0.832*** 0.161 0.118 *** 0.711 ** 0.026 0.091 *** 0.746 *** -0.301

(0.029) (0.294) (0.259) (0.027) (0.298) (0.264) (0.016) (0.284) (0.277)

p-fvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

R2 0.131 0.206 0.144 0.111 0.207 0.143 0.190 0.211 0.166

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Column 2-4 of table 4.9 consider utilization of excess cash in competitive

industries. Competition is a dummy variable with 1 for companies performing in

competitive industries at particular year and 0 for companies from concentrated

industries at particular year. Dummies are assigned on basis of HHI index divided into

tercile, with lowest tercile assigned as competitive industries and highest tercile is

assigned as concentrates industries. Column 2 considers utilization of excess cash in

the form of industry adjusted capital expenditure (capex). The interaction term of

lagged excess cash and competition dummy shows negative and significant effect on

industry change in capex. The result portrays that excess cash in competitive

industries spend 0.969 less on industry adjusted capex compared to concentrate

industries. The result is supported by agency theory that external market discipline is

one of tool to mitigate agency problem beside efficient internal governance

(Haushalter et al., 2007; Alimov, 2014).

Similarly, column 3 of table 4.9 shows effect of spending excess cash in

competitive industries on utilization of excess cash in the form of dividend. The result

shows that interaction of lagged excess cash and competitive dummy has insignificant

effect on dividend. The result shows that shareholders give less value to dividend in

competitive industries compared to concentrated Industries. The result is consistent

with substitution effect argument of dividend that dividend is substitute for

governance in resolving agency problem.

147

On the other hand, Column 4 of table 4.9 shows effect of excess cash in competitive

industries on utilization of excess cash in the form of diversification. The result shows that

excess cash in competitive industries spend less on diversification. Firms engage in

diversification due to agency problem (Jensen, 1986) and entrenched managers want to

mitigate their own level of risk (Chen & Steirner, 2000). Moreover, external market

discipline has role in reducing agency problem (Amman et al., 2011). Therefore, excess cash

less utilized on diversification in competitive industries.

Similarly, Columns 5-7 of Table 4.9 consider utilization of excess cash in Shariah

compliant firms. Column 2 considers utilization of excess cash in the form of industry

adjusted capital expenditure (capex) in Shariah compliant firms. The result of interaction

between lagged excess cash and Shariah compliance dummy shows insignificant effect on

industry adjusted capital expenditure (capex). The result is supported by substitution

argument that Shariah compliance is substitute to governance. Since, Shariah compliant

firms maintain lower debt therefore we can conclude that Shariah compliance is substitute to

governance. This indicates that excess cash in Shariah compliant firm utilize less on

industry adjusted capital expenditure (capex).

Column 6 considers utilization of excess cash in the form of dividend payments in

Shariah compliant firms. The interaction of lagged excess cash and Shariah compliance

dummy shows positive and significant effect on dividend. The result is supported by

dividend outcome model that firms distribute excess cash in form of dividend whenever

agency problem is lower. Since, agency problem are lower in Shariah compliant firms

(Hayat & Hassan, 2017) that is why excess cash in Shariah compliant firms has positive and

significant effect on dividend. On the other hand, column 7 of table 4.9 shows excess cash in

Shariah compliant firms have significant and negative relationship with diversification.

Previous researches (e.g., Lang & Stulz, 1994; Chen & Steiner, 2000; Rajan et al., 2000;

148

Subramaniam et al., 2013) show that firms goes towards diversification due to agency

problem. However, Shariah compliant firms have low level of agency problem due to their

structure that’s why Shariah compliant firms utilize less excess cash on diversification. On

the basis of table 4.9 hypothesis of this research is supported that excess cash is efficiently

utilized in Shariah compliant firms because Shariah compliance is substitute to strong

internal governance.

Finally, columns 8-10 of Table 4.9 consider utilization of excess cash in family

firms. Column 8 considers utilization of excess cash in the form of industry adjusted capital

expenditure (capex) in family firms. The result shows that interaction of lagged excess cash

and family firms’ dummy (with 1 for family firms and 0 for non-family firms) has positive

and significant effect on industry capital expenditure. This indicates that family firms

inefficiently utilize excess cash due to high agency problem which results in lower value of

firm (Boubaker et al., 2015).

Similarly, column 9 of table 4.9 considers utilization of excess cash in the form of

dividend in family firms. The result shows that interaction of lagged excess cash with family

dummy has significant negative effect on dividend. The result shows that family firms do

not distribute excess cash in form of dividend due to high agency problem. Benjamin,

Razak, Wassiuzzaman, Mokhtarania, and Nejad (2005) also found negative relationship of

family ownership on dividend due to agency problem. On the other hand, column 9 of table

4.9 considers utilization of excess cash in the form of diversification in family firms. The

result of interaction between lagged excess cash and family dummy shows significant effect

on diversification. The result is supported by agency theory and empire building hypothesis

that family firms want to build empire for their family. Moreover, family firms serve the

interest of their family members and want to transfer business to next generation that’s why

family firms involve in diversification (Lien & Li, 2013). Therefore, family firms divert

149

from the goal of maximizing firm value of firm in the wake of transferring firm to next

generation (Grote, 2003).

On the basis of table 4.9 hypothesis of this research is supported that excess cash is

inefficiently utilized in family firms due to agency problem.

4.6 Effect of corporate governance on excess cash and firm performance relationship

Efficient utilization of excess cash with strong corporate governance improves

overall performance of company. Dittmar and Mahrt-Smith (2007) also shows that efficient

utilization of excess cash lead to increase performance of the company. Therefore, this

section investigates the effect of corporate governance and excess cash on firm performance

corresponding to objective 4 and sub objectives 4a, 4b, and 4c.

Many researchers (e.g., Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et

al., 2013) investigate the relationship of excess cash in strong and poor governaned firms on

operating profit. Though, total factor productivity growth is a superior measure for

performance of company compared to standard accounting ratios on basis that standard

accounting ratios have chance of manipulation by firm (Pattanayak, 2010 & Tian and Twite,

2011). Utilization of total factor productivity growth as a measure for performance in the

relationship of excess cash is lacking in the extant literature. Therefore, this study

investigates relationship of excess cash on firm performance under good governance using

total factor productivity growth for performance.

Section 4.4.1 investigates role of corporate governance on excess cash and total

factor productivity growth relationship, while for robustness section 4.4.2 investigates role

of corporate governance on excess cash and industry adjusted ROA relationship.

150

Before considering the combined effect of corporate governance and excess cash on

firm performance, the individual effect of excess cash on firm performance was investigated

across different firms including firms from competitive industries, concentrated industries,

family owned firms, non-family owned firms, Shariah compliant firms and non-Shariah

compliant firms respectively. Appendix 2 shows effect of lagged excess cash effect on total

factor productivity growth and industry adjusted ROA in competitive industries, family

firms and Shariah compliant firms without considering corporate governance variable. The

results indicate that the effect of excess cash on firm performance vary across the selected

groups of firms. Therefore, the role of product market competition, concentration, family

ownership, and Shariah compliance has been considered in the combined relationship of

corporate governance and excess cash with total factor productivity growth.

4.6.1 Role of corporate governance on excess cash and total factor productivity growth

relationship

Table 4.10 shows effect of excess cash on total factor productivity growth and

examined role of corporate governance. Moreover, table 4.10 also portrays effect of excess

cash on total factor productivity growth under good governance in competitive and

concentrated industries; family and non-family firms; Shariah and non-Shariah compliant

firms. The Table 4.10 reports results of seven models. Dependent variable for each model is

the total factor productivity (TFP) growth. The first model shows role of corporate

governance on excess cash and TFP growth relationship in overall sample. Second model

shows role of corporate governance on excess cash and TFP growth in competitive

industries. Third model shows role of corporate governance on excess cash and TFP growth

relationship in concentrated industries. Fourth model shows role of corporate governance on

excess cash and TFP growth in family firms. Fifth model shows role of corporate

governance on excess cash and TFP growth in non-family firms, while sixth and seventh

151

model consider Shariah compliant and non- Shariah complaint firms and shows role of

corporate governance on excess cash and TFP growth relationship.

Table 4.10: Role of corporate governance on excess cash and total factor productivity growth

relationship

TFPG Overall com conc family N-family sharia N-sharia

excesst-1 0.006 *** 0.006 *** -0.159 0.003 0.012 *** 0.006**` 0.006 ***

(0.002) (0.002) (0.247) (0.002) (0.004) (0.003) (0.003)

excesst-1*gov 0.488 *** 0.612 *** 0.207 0.819 *** 0.213 0.503* 0.515 *

(0.186) (0.226) (0.350) (0.225) (0.387) (0.260) (0.287)

gov -0.032 *** -0.027 * -0.043 -0.035** -0.028 -0.038*** -0.024

(0.013) (0.014) (0.028) (0.014) (0.033) (0.021) (0.017)

cflow -0.209*** -0.160 ** 0.585*** -0.294*** -0.185** -0.240*** -0.242***

(0.051) (0.064) (0.100) (0.071) (0.081) (0.080) (0.078)

indcv 0.111 0.129 0.093 0.257* 0.075 0.070 0.187

(0.097) (0.116) (0.179) (0.144) (0.145) (0.139) (0.147)

lev 0.066** 0.105 *** 0.117** 0.099** 0.108** 0.059 0.094*

(0.032) (0.040) (0.053) (0.045) (0.054) (0.048) (0.051)

nwc 0.025 0.059 * -0.034 0.120*** 0.003 0.011 0.067

(0.027) (0.035) (0.047) (0.040) (0.040) (0.039) (0.041)

size 0.003 0.004 0.001 0.008 0.000 0.006 0.002

(0.004) (0.005) (0.005) (0.005) (0.006) (0.005) (0.006)

capex -0.058 -0.056 0.000 -0.089* 0.012 -0.196*** 0.155***

(0.039) (0.051) (0.086) (0.050) (0.066) (0.053) (0.060)

mtob -0.017 -0.027 * -0.060*** -0.023*** -0.022 -0.018 -0.010

(0.012) (0.015) (0.020) (0.017) (0.019) (0.018) (0.018)

cons 0.960 *** 0.908 *** 0.920*** 0.890*** 0.991*** 0.948*** 0.970***

(0.066) (0.089) (0.095) (0.088) (0.110) (0.085) (0.123)

f-pvlaue 0.000 0.000 0.000 0.000 0.003 0.001 0.000

R-square 0.101 0.101 0.225 0.131 0.155 0.129 0.169

N 1080 690 387 663 417 270 530

Second column shows role of corporate governance on excess cash and total factor productivity growth

relationship in overall sample. Third column shows role of corporate governance on excess cash and total

factor productivity growth relationship in competitive industries, while fourth column considers concentrated

industries. Fifth column considers the same phenomenon in family firms column, while sixth column considers

152

non-family firms. Seventh column considers Shariah compliant firms and eighth column considers in non-

Shariah compliant firms. Dependent variable is total factor productivity growth. Independent variable is lagged

excess cash which is difference between actual and residual of determinant of cash holding. Gov is dummy and

measured by dividing corporate governance index in terciles on yearly basis with 1 for firms in highest tercile

and 0 for firms in middle and lowest tercile. Cflow stands for cash flow, indcv stands for industry adjusted cash

flow volatility, lev stands for leverage, nwc stands for net working capital, size stands for size of the firm and

mtob stands for market to book ratio. All models are run with time dummies, industry fixed effect and standard

error cluster with firm level. First term is coefficient of variables and term in bracket shows standard error.

*,**,*** shows significance at 10%,5% and 10%.

Second column of Table 4.10 shows that excess cash with good corporate

governance increase total factor productivity growth. The interaction term between lagged

excess cash and governance dummy shows positive and significant effect on total factor

productivity growth. The result portray that excess cash under good governance increases

total factor productivity growth and indicates efficient utilization of excess cash. The result

is again supported by agency theory that due to agency problem managers waste value asset

i-e, excess cash and decreases performance of firm. The coefficient of interaction term is

0.488 indicating that excess cash have 0.488 more effect on total factor productivity growth

under strong governance compared to poor governance. These findings are in line with

Harford et al. (2008) also found that lagged excess cash with strong governance has positive

effect on firm performance. Similarly, Dittmar and Mahrt-Smith (2007) also found that the

interaction of lag excess cash with governance dummy has positive and significant effect on

firm performance. They concluded that excess cash under strong governance increases

operating profit which indicates that excess cash is efficiently utilized under good

governance. Our findings support H4a hypothesis that excess cash with strong corporate

governance increases total factor productivity growth.

Control variables including cash flow has significant negative effect on total factor

productivity growth, industry adjusted cash flow volatility has insignificant effect on total

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factor productivity growth, leverage has significant positive effect on total factor

productivity growth. Size has insignificant effect on total factor productivity growth, while

capex has insignificant effect on total factor productivity growth. Growth opportunities

measured by market to book ratio has insignificant effect on total factor productivity growth.


competitive industries

In second step we have split the sample into HHI terciles. The industries belonging

to lowest tercile are competitive industries, while highest tercile represent concentrated

industries. The result presented in column 3 shows that lagged excess cash with strong

governance dummy have positive and significant effect on total factor productivity growth

in competitive industries. This result confirms complementary hypothesis instead of

substitution argument. On the contrary, column 4 indicates that lagged excess cash

interacted with strong governance dummy shows insignificant effect on total factor

productivity growth in concentrated industries that again support complementary hypothesis.

The result is in line with Pattanayak (2010) who investigated effect of corporate governance

on firm performance using total factor productivity growth as proxy for firm performance in

competitive and concentrated industries in Indian non- financial sector. He found that

corporate governance has significant effect in competitive industries compared to

concentrated industries and supported complementary hypothesis that external market

discipline needs efficient firm level governance to improve total factor productivity growth.

Similarly, Koke and Jens (2001) found that corporate governance and external market

discipline has complementary effect in total factor productivity relationship. In contrast of

Nickell, Nicolitsas, and Drydin (1997); Tian and Twite (2011) found substitution effect

between corporate governance and product market competition on total factor productivity

relationship.

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The result of dissertation shows that role of corporate governance is significant on

excess cash and total factor productivity growth in competitive industries compares to

concentrated industries. The result supported H4b hypothesis that corporate governance has

significant role on excess cash and total factor productivity growth in competitive industries.


family firms

Similarly, in the third step the research investigates effect of excess cash with

corporate governance on total factor productivity growth in family and non-family firms.

The result presented in column 4 &5 shows that excess cash with good corporate governance

has positive and significant effect on total factor productivity growth in family firms

compare to non-family firms. The result posits that lagged excess cash with good corporate

governance has positive and significant effect on total factor productivity growth in family

firms. On the other hand, lagged excess cash with good corporate governance has

insignificant effect on total factor productivity growth in non-family firms. According to

Anderson and Reeb (2003) family control firms has low performance compared to non-

family firms due to agency problem. This indicates that family firms can improve

performance by reducing agency problems. Family members expropriate free cash flows on

the cost of minority investors that is why proper governance is needed to protect rights of

minority shareholders (Shleifer & Vishny, 1997). So, due to agency problem excess cash in

family firms decrease total factor productivity growth and efficient governance is needed to

improve total factor productivity growth in family firms.

The result supported H4c hypothesis that corporate governance has significant role

on excess cash and total factor productivity growth relationship in family firms.

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4.6.4 Effect of excess cash with good corporate governance on total factor productivity

growth in Shariah compliant firms

Finally, we divide sample into Shariah and non-Shariah compliant firms and

checked the effect of lagged excess cash with corporate governance on total factor

productivity growth in Shariah and non- Shariah compliant firms. The result shows that

interaction term of lagged excess cash and strong governance dummy have positive and

significant effect on total factor productivity growth in both Shariah and non-Shariah

compliant firms. The result postulates that Shariah compliance does not matter on the effect

of excess cash on total factor productivity growth under good governance.

The result does not supported H4d hypotheses that effect of corporate governance on

excess cash and total factor productivity growth is significantly different in Shariah

compliant firms and non-Shariah complaint firms.

4.6.5 Effect of corporate governance on excess cash and industry adjusted ROA

relationship

Following Dittmar and Mahrt-Smith (2007); Harford et al. (2008); Jain et al., (2013)

this section investigates the relationship of lagged excess cash with good corporate

governance on industry adjusted ROA for robustness check.

Table 4.11 shows role of corporate governance on excess cash and industry adjusted

ROA relationship. Moreover, role of corporate governance on excess cash and industry

adjusted ROA relationship is investigated in competitive and concentrated industries; family

and non-family firms; Shariah and non-Shariah compliant firms.

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Table 4.11: Role of corporate governance on excess cash and Industry adjusted ROA

relationship

indroa Full Com Conc Family

N-

family Sharia

N-

sharia

excesst-1 -0.927 *** 0.006 0.003 0.002 0.013 *** -0.006 0.004 ***

(0.074) (0.114) (0.002) (0.001) (0.002) (0.005) (0.001)

excesst-1*gov 0.253 ** 0.540 *** 0.810 *** 0.609 *** 0.311 0.302 0.555 ***

(0.106) (0.109) (0.277) (0.140) (0.207) (0.276) (0.122)

gov -0.030 *** -0.039 *** -0.086 *** -0.047 *** -0.017 -0.040 -0.046 ***

(0.007) (0.007) (0.022) (0.009) (0.017) (0.024) (0.008)

cflow 0.254 *** 0.377 *** 0.301 *** 0.328 *** 0.345 *** 0.261 *** 0.371 ***

(0.030) (0.031) (0.067) (0.044) (0.044) (0.105) (0.032)

indcv -0.181 *** -0.201 *** -0.050 0.029 -0.323 *** -0.663 *** -0.100

(0.054) (0.056) (0.145) (0.089) (0.078) (0.192) (0.061)

lev 0.063 *** 0.008 -0.073 * -0.031 0.045 -0.079 0.004

(0.019) (0.019) (0.043) (0.027) (0.029) (0.062) (0.020)

nwc 0.117 *** 0.062 *** -0.013 0.019 0.050 ** -0.054 0.041 **

(0.017) (0.017) (0.032) (0.025) (0.022) (0.046) (0.017)

size -0.005 ** -0.005 ** -0.001 0.003 -0.009 *** -0.015 * -0.002

(0.002) (0.002) (0.005) (0.003) (0.003) (0.008) (0.002)

capex 0.022 0.009 0.002 -0.020 0.046 -0.064 0.008

(0.022) (0.024) (0.049) (0.031) (0.036) (0.071) (0.025)

mtob -0.003 0.023 *** 0.056 *** 0.037 *** 0.015 0.026 0.034 ***

(0.007) (0.007) (0.016) (0.011) (0.010) (0.029) (0.008)

cons -0.055 0.035 -0.006 -0.062 0.068 0.235 * -0.031

(0.036) (0.042) (0.076) (0.053) (0.058) (0.124) (0.042)

p-value 0.000 0.000 0.000 0.000 0.000 0.000 0.000

R-square 0.441 0.478 0.289 0.314 0.547 0.650 0.368

Second column shows role of corporate governance on excess cash and industry adjusted ROA in overall sample.

Third column shows role of corporate governance on excess cash and industry adjusted ROA in competitive

industries, while fourth column considers concentrated industries. Fifth column considers the same phenomenon in

family firms column, while sixth column considers non-family firms. Seventh column considers Shariah compliant

firms and eighth column considers in non-Shariah compliant firms. Dependent variable industry adjusted ROA.

Independent variable is lagged excess cash and gov dummy which is measured by dividing corporate governance

index in terciles on yearly basis with 1 for firms in highest tercile and 0 for firms in middle and lowest tercile. Cflow

stands for cashflow, indcv stands for industry adjusted cash flow volatility, lev stands for leverage, nwc stands for net

working capital, size stands for size of the firm and mtob stands for market to book ratio. All models are run with

157

time dummies, industry fixed effect and standard error cluster with firm level. First term is coefficient of variables

and term in bracket shows standard error.*,**,*** shows significance at 10%,5% and 10%.

The result shows that effect of lagged excess cash interacted with governance

dummy shows positive and significant effect on industry adjusted ROA. The result shows

that firms efficiently utilize excess cash under good governance, and increases industry

adjusted operating profit. The result is in line with the work of Dittmar and Mahrt-Smith

(2007); Harford et al. (2008); Jain et al. (2013) also suggested positive effect of lag excess

with good governance on industry adjusted ROA. The result of this research also portrays

that excess cash under good governance has high operating profit than the industry median.

Similarly, when the sample is split in competitive and concentrated industries and

result shows that lagged excess cash with good governance has positive and significant

effect on industry adjusted ROA in both competitive and concentrated industries. The third

and fourth column of table 4.11 shows that strong corporate governance increases industry

adjusted ROA in both competitive and concentrated industries and the result rejected both

complementary and substitution effect arguments. This result is in line with Jain et al.

(2013).

On the other hand, when the sample is divided in family and non-family firms and

the result shows that lagged excess cash with strong governance increase industry adjusted

operating profit in family firms as compared to non-family firms. The interaction of lagged

excess cash and corporate governance dummy shows insignificant effect on industry

adjusted ROA in non-family firms (See column 5 and 6 in table 4.11). The coefficient value

of 0.609 shows that lagged excess cash within good governance firms’ increases industry

adjusted ROA more as compare to lagged excess cash within bad governance firms. In line

with Shleifer and Vishny (1997); Anderson and Reeb, (2003) the result is supported by

158

agency theory that family firms have high agency problems compared to non-family firms

that is why excess cash with strong governance increases industry adjusted ROA in family

firms.

Finally, this research investigates effect of lagged excess cash interacted with

corporate governance dummy on industry adjusted ROA in Shariah and non-Shariah

compliant firms. The result shows that interaction term is insignificant in Shariah compliant

firms. This result is supported by substitution effect argument which suggests that Shariah

compliance is alternate to good governance and corporate governance does not matter in

Shariah compliant firms. In contrast, the coefficient of interaction between lagged excess

cash and governance dummy is non-Shariah compliant firms are 0.544 and significant. The

result indicates that excess cash effect on industry adjusted ROA is 0.544 more in non-

Shariah compliant firms with good governance compared to the non-Shariah compliant

firms having bad governance.

4.7 Effect of diversification on value of cash holding

Corporate diversification is the most important among three form of spending excess

cash in Pakistan (i.e., industry adjusted capital expenditure, dividend, and diversification)

due to the dominancy of family firms. The family firms are more likely to involve in

corporate diversification for empire building for family members and their successors. The

existence of diversified firms all over the globe including Pakistan is the proof that largely

firms involve in diversification. Moreover, diversified firms have high agency problems

compare to stand-alone firms and reduce firm value through cross-subsidization. The current

dissertation considers this issue and investigated direct effect of corporate diversification on

value of cash holding and check whether diversification reduce value of cash holding due to

agency problem.

159

Column 2 of table 4.12 shows effect of diversification on value of cash holding. The

result shows that diversification decrease marginal value of cash by -.225 for one Pakistani

rupee. The result is supported by agency theory and empire building hypothesis that due to

conflict between managers and owner, entrenched managers invests excess cash on value

destroying diversification. This value destroying investment posits negative effect on excess

return. And managers normally create their empire by investing in different industries which

further benefit the mangers and not shareholders. The current result is supported by Tong

(2011) who also found negative effect of diversification interaction with change in cash on

firm excess return. In contrast, Galvan, Pindado and Torre (2014) suggest that relationship

of diversification with firm value is non-linear, i.e., it first posits negative effect on firm

value and then posits positive effect on firm value.

The methodology of this study is different from methodology of Galvan et al. (2014)

because we follow Faulkender and Wang (2006); Dittmar and Mahrt-Smith (2007); Tong

(2011). On the other hand, Galvan et al. (2014) used Tobin Q for measuring firm value,

while the present research uses excess return as a proxy for firm value.

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Table 4. 12: Effect of diversification on value of cash holding(dependent: excess return)

Overall gov=1 gov=0 comp conc family Non-family shariah

non-

shariah

⊿CH 0.441 * 0.526 0.498 0.759 ** -0.379 0.716 * 0.287

0.574 0.182

(0.267) (0.475) (0.336) (0.380) (0.399) (0.371) (0.489)

(0.488) (0.333)

diver*⊿CH -0.268 ** 0.528 *** 0.238 0.457 *** 0.225 -0.336 *** -0.101 0.504 *** 0.156

(0.109) (0.199) (0.152) (0.161) (0.179) (0.128) (0.296) (0.156) (0.195)

diver 0.000 0.025 -0.012 -0.007 0.003 -0.013 -0.030 -0.011 0.020

(0.027) (0.051) (0.032) (0.036) (0.038) (0.037) (0.042) (0.035) (0.040)

⊿Earning 0.019 ** 0.006 0.039 *** 0.020 * 0.083 *** 0.021 ** 0.107 ** 0.036 *** -0.031

(0.009) (0.014) (0.013) (0.011) (0.024) (0.010) (0.042)

(0.011) (0.025)

⊿NA 0.006 *** 0.011 *** 0.013 *** 0.004 -0.031 ** 0.007 *** 0.027 ** 0.009 ** -0.004

(0.002) (0.004) (0.004) (0.002) (0.014) (0.002) (0.013)

(0.004) (0.005)

⊿INT -0.129 *** -0.251 *** -0.055 -0.113 ** -0.424 *** -0.130 *** 0.080

-0.209 *** 0.000

(0.033) (0.087) (0.049) (0.036) (0.142) (0.035) (0.181)

(0.050) (0.071)

⊿D -0.148 *** -0.169 ** -0.051 -0.141 *** -0.018 -0.152 *** 0.691 * 0.043 0.126

(0.043) (0.085) (0.067) (0.053) (0.097) (0.046) (0.360)

(0.092) (0.132)

CHt-1 0.105 ** 0.110 0.084 0.230 *** 0.154 *** 0.081 * 0.210

0.051 0.139 **

(0.044) (0.067) (0.073) (0.070) (0.058) (0.049) (0.150)

(0.060) (0.069)

CHt-1*⊿CH -0.014 *** 0.189 *** -0.008 -0.021 *** 0.061 -0.012 *** -0.305

0.132 ** -0.010

(0.004) (0.062) (0.006) (0.005) (0.060) (0.004) (0.288)

(0.054) (0.007)

mktlev 0.222 *** 0.219 ** 0.219 *** 0.237 *** 0.162 *** 0.224 *** 0.090

0.188 *** 0.321 ***

(0.051) (0.108) (0.059) (0.068) (0.078) (0.071) (0.078)

(0.068) (0.081)

161

mktlev*⊿CH -0.658 ** -0.439 ** -0.696 * -0.709 *** 0.308 -0.806 ** -0.011

-0.768 * -0.097

(0.312) (0.182) (0.388) (0.411) (0.542) (0.424) (0.606)

(0.404) (0.401)

cons -0.127 *** -0.213 *** -0.090 -0.177 ** -0.072 -0.097 -0.096

-0.143 * -0.119

(0.059) (0.119) (0.068) (0.087) (0.073) (0.085) (0.079)

(0.082) (0.081)

F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.002

0.000 0.001

R2 0.053 0.128 0.057 0.081 0.118 0.067 0.086

0.097 0.076

N 1385 393 992 889 493 926 459 530 855

Table4.4 shows effect of diversification on value of cash holding. Second column shows effect of diversification value of cash holding, Third column shows effect of

diversification on value of cash holding in well governed firms, while fourth column shows effect of diversification on value of cash holding in poor governance firms. Fifth

column shows effect of diversification on value of cash in competitive industries, while sixth column shows effect of diversification on value of cash holding in concentrated

industries. Seventh column shows effect of diversification on value of cash holding in family firms and eight column shows effect of diversification on value of cash holding

in non-family firms. Column nine shows effect of diversification on value of cash holding in Shariah compliant firms and column tenth shows effect of diversification on

value of cash holding in non-Shariah compliant firms. The dependent variable is excess return which is calculated through Fama and French (1993) size and book to market

ratio using monthly data from 2007 to 2014 and then annualize and deducted from annual return of individual firm. Diversification is dummy variable 1 for diversified firms

and 0 for non-diversified firms Gov is dummy 1 is measured through dividing corporate governance index in terciles highest tercile is assigned 1 and 0 for the middle and

lowest tercile. Competition is measured through HHI index dividing in tercile 1 lowest tercile and 0 for middle and lowest tercile. Other control variables are ⊿CH shows

change in cash, ⊿Earning shows change in earning, ⊿NA shows change in net asset, ⊿INT shows change in interest, ⊿D shows change in dividend, CHt-1 is lag cash all

controlled variables are divided by lag market value of equity. First term shows coefficient of variable and term in bracket is standard error. All models are run with time

dummies and industry fixed effect and standard error cluster firm firm level, *,**,*** shows significance at 10%, 5% and 1%.

162

The results indicate that marginal value of diversified firm is -0.225. The objective H5a

is checked that whether diversification reduces value of firm due to agency problem. The

negative sign indicates that shareholders are getting negative return for 1PKR extra investment

in diversified firm.

The result supported H5a that diversification reduces value of cash holding due to

agency problem.

4.7.1 Effect of corporate diversification on value of cash holding in good and poor

governance firms

The research further investigated effect of diversification on value of cash holding by

splitting the sample into good governance firms and low governance firm. The result of column

3 of table 4.12 shows that the interaction of diversification with change in cash has positive and

significant effect on excess return in good governance firm. This result is supported by agency

theory that shareholders give more value to diversification in good governed firms compared to

bad governed firms. Corporate governance alters the negative relationship of diversification and

value of cash holding. The result also posits that due to good corporate governance, agency

problem is mitigated and mangers invest in value creating diversification. This result is in line

with Tong (2011) who also found that diversification has positive effect on value of cash

holding in good governed firms. The result of column 4 of table 4.12 further posits that

diversification interaction with change in cash has insignificant effect on value of cash in poor

governed firms. The marginal value of cash holding under bad governance is 0.279 (0.498+(-

0.008*0.211)+(-.696*0.655)+0.238) which is significantly lower compared to diversification in

good governed firms. The marginal value of diversification is 0.554 greater in firms that have

good governance compared to poor governed firms.

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The result supported H5b that diversification increase marginal value of cash holding in

good governed firms.

4.7.2 Effect of corporate diversification on value of cash holding in competitive and


The research further investigates effect of diversification on value of cash in competitive

industries and in concentrated industries (see, column 5 & 6 of table 4.12). Agency theory and

empirical research posits that competition work as external market discipline and claim that

despite of bad governance mangers act in best interest of shareholder due to external market

pressure. This indicates that competition in product market mitigates agency problem even

when the firm level governance is poor. The result of column 5 depicts that the interaction of

diversification with change in cash shows an increase of 0.457 in the shareholders wealth in

diversified firms compared to a stand-alone firms in competitive industries.

. The marginal effect of diversification on value of cash under competitive industry is

0.757 measured as (0.759+ (-0.021*0.212) + (-0.709*0.642)+0.457). Similarly, the effect of

diversification interaction with change in cash shows insignificant effect on value of cash

holding in concentrated industries due to lack of external market discipline. The marginal value

of diversification on shareholder wealth for one extra PKR invested in concentrated industries is

0.019 measured as (0.379+(0.061*0.1875)+(0.308*0.5277)+0.225). The difference of

diversification for 1PKR extra rupee in competitive and concentrated industry is 0.738. The

result indicates that diversification increases value of cash holding in competitive industries due

to mitigation of agency problem by external market discipline and decreases value of cash

holding in concentrated industries due to lack of external market discipline.

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The result supported H5c hypothesis that Corporate diversification has positive effect on

value of cash holding in competitive industries.

4.7.3 Effect of corporate diversification on firm value in family and non-family firms

The result of column 7 and 8 of table 4.12 considers effect of diversification on value of

cash holding in family owned and non-family owned firms respectively. The overall result is

comparatively more significant in family owned firms. Managers of family owned business are

engaged in diversification due to agency and also supported to empire building hypothesis.

Controlling shareholders in family owned firms want to transfer their business to next

generation by creating their own empire at the cost of minority shareholders which is the classic

example of agency problem. The result shows that effect of interaction of diversification with

change in cash shows significant effect on value of cash holding in family firms.

The result shows that diversification interaction is -0.336, and result postulates that

diversification decreases shareholder investment for extra 1PKR by 0.336 in family firms. The

result also shows that diversification interaction has insignificant effect in non-family firms.

The marginal value for 1PKR to shareholders in family firm is -0.153PKR that shows value of

cash decreases due to diversification in family owned compared to non-family firms. On the

other hand, in non-family firms the effect of diversification on value of cash is 0.1444PKR for

one extra Pakistani rupee to the shareholders. The difference between effect of diversification

on value of cash in family and non-family firms is -0.298. The result supported H5d that

diversification reduces value of cash holding in family firms.

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4.7.4 Effect of diversification on value of cash holding in Shariah compliant firms

Similarly, the last two columns report the effect of diversification on value of cash in

Shariah compliant and non Shariah compliant firms. The nature of Shariah compliant firms is

different from non- Shariah compliant firms in terms of liquidity, debt ratio and investment.

Research (like, Hayat & Hassan, 2017; Ullah & Rizwan, 2018) shows that Shariah compliance

is substitute to governance because Shariah compliant firms maintain low debt and low debt is

substitute for good governance. Moreover, Shariah complaint firms also maintained low liquid

to asset as compared non-Shariah compliant firms. Therefore, the free cash flow problem is

comparatively lower in Shariah compliant firms compared to non Shariah compliant firms.

The result shows that diversification interaction with change in cash is positive and

significant in Shariah compliant firms as compared to non-Shariah compliant firms. Empirical

result of this study shows that marginal value of shareholder is in Shariah compliant firm is

0.838 PKR compared to 0.272 in non-Shariah compliant firms. The result shows that

diversification decreases value of cash in non-Shariah compliant firms about 0.565PKR for one

extra Pakistani rupee devoted by investors. The result indicates that Shariah compliance is

alternative for corporate governance and diversification increases firm value more in Shariah

compliant firms compared to non-Shariah compliant firms. The effect of diversification on

value of cash holding is lower in non-Shariah compliant firms due to agency problem.

The result supported H5e hypothesis that diversification increases value of cash holding

in Shariah compliant firms.

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CHAPTER 5

CONCLUSION

Cash holding has got importance after financial crises because the firms having

sufficient funds proved more viable during crises period. Firms were facing difficulty in

generating funds during crises period due to capital market inefficiency. Precautionary motive

for cash is most prominent in literature which posits that firms hold cash to defend themselves

from sudden external shocks. The financial hierarchy theory also suggests that internal funds are

the cheaper source of financing compared to external financing.

Though, holding cash is beneficial for firms however, cost is also attached with cash

holding. Therefore, equilibrium is must between benefit of cash holding and cost of cash

holding. If the benefit of cash holding is less from the cost of cash holding it causes reduction in

firm value. The most prominent cost attached with cash holding is the agency cost. Cash is

imperative asset which can be easily expropriated due to agency problem by entrenched

mangers and controlling shareholders for their personal interests. This dissertation investigated

effect of corporate governance on different facets of cash management. The dissertation also

examined whether corporate governance effects vary on different facets of cash management

across different industries and ownership structures. For this purpose, the thesis investigated the

role of product market competition, family ownership and Shariah compliance on the

relationship of corporate governance with different facets of cash management. This study is

important in context of Pakistan because the law enforcement is weak and inefficient compared

to developed economies. Moreover, it posits several findings.

167

First, the present study investigates the effect of corporate governance on level of cash

holding. Findings suggest that corporate governance has negative significant effect on level of

cash holding which support flexibility hypotheses presented by Harford et al. (2008). Moreover,

provides answer to a query, whether the relationship of corporate governance and level of cash

holding varies across different forms of industries and ownership structures. The study

investigates the role of product market competition, family firms’ ownership, and Shariah

compliance on the relationship of corporate governance and level of cash holding relationship.

The result shows that product market competition has substitution effect for corporate

governance in relationship with cash holding. Similarly, family ownership also has significant

effect on corporate governance and cash holding relationship. On the other hand, Shariah

compliance has insignificant effect on corporate governance and cash holding relationship.

Second, this research investigates effect of corporate governance on value of cash

holding and the role of product market competition, family ownership, and Shariah compliance

on the relationship of corporate governance and value of cash holding is investigated. Previous

researches captured value of firm through Tobin Q. However, this research follows Faulkender

and Wang (2006); Dittmar and Mahrt-Smith (2007) to capture value of firm through change in

cash. The measurement of firm value through cash is more valid approach to measure value of

firm because cash is more prone to appropriation by mangers and controlling shareholders in

comparison of other type of assets (Dittmar & Mahrt-Smith, 2007; Jain et al., 2013). The result

posits that corporate governance and change in cash interaction has positive and significant

effect on excess return indicating that corporate governance significantly increases value of cash

holding.

168

Furthermore, the research revealed that corporate governance significantly increases

value of cash holding in competitive industries compared to concentrated industries which

supports complementary hypothesis i.e., external market discipline need efficient corporate

governance for mitigating agency problems. Similarly, the results indicate that corporate

governance increases value of cash holding in family firms. Family firms have high agency

problem between controlling shareholders and minority shareholders and in family firms

corporate governance is needed to mitigate agency problem and significantly increase value of

cash holding. On the other hand, Shariah compliant firms have low agency problems due to

their structure. Therefore, corporate governance has insignificant effect on value of cash holding

in Shariah compliant firms which support substitution effect argument that Shariah compliance

is substitute for corporate governance.

Third, the study attempts to investigate whether corporate governance increases value of

cash holding through efficient utilization of excess cash. This research investigated three

possible way of spending excess cash i.e., industry adjusted capital expenditure, dividend and

corporate diversification. The result shows that corporate governance has positive and

significant effect on spending of excess cash. Similarly, corporate governance shows significant

role in the efficient utilization of excess in competitive industries which is consistent with

complementary hypotheses. Moreover, the result shows that role of corporate governance has

significant effect on utilization of excess cash in family firms because mitigating agency

problem in family firms, controlling shareholders efficiently utilize excess cash. On the other

hand, since Shariah compliance work as alternative to corporate governance on the basis of

substitution effect argument. Therefore, good governance has insignificant role in spending of

excess cash in Shariah compliant firms.

169

Fourth, since that excess cash increases performance of the company due to efficient

utilization of excess cash which further effect value of firm (Dittmar & Mahrt-Smith, 2007).

Therefore, this study investigates role of corporate governance on excess cash and firm

performance and also checks the role of corporate governance in competitive and concentrated

industries, family and non-family firms and Shariah and non-Shariah compliant firms. Total

factor productivity growth has been used as proxy for firm performance, while for robustness

purpose industry adjusted ROA is also used as a proxy of performance. Total factor productivity

growth is more appropriate approach than the single accounting ratio because single accounting

ratio has chance of manipulation (Tian & Twite, 2011). The study revealed that excess cash

increases total factor productivity growth under good governance.

Similarly, corporate governance has significant role on effect of excess cash and total

factor productivity growth in competitive industries compared to concentrated industries as

suggested by support of complementary hypothesis. Findings suggest that excess cash increases

total factor productivity growth under good governance in competitive industries. Moreover,

joint effect of corporate governance and excess cash have positive and significant effect on total

factor productivity growth in family firms compared to non-family firms. The result shows that

family firms have high agency problem between controlling shareholders and minority

shareholders which is mitigated through corporate governance. Therefore, excess cash is better

utilized in family firms under good governance which leads to increase in total factor

productivity growth. On the other hand, corporate governance and excess cash joint effect has

insignificant effect on total factor productivity growth in Shariah compliant firms as suggested

by the substitution affect argument.

170

Finally, since the extant literature shows that firms engage in diversification due to

agency problem and destroy value of firm (Tong, 2011). Moreover, our findings suggest that

among the three ways of spending excess cash diversification is very significantly related to

excess cash. Therefore, this study investigates effect of corporate diversification on value of

cash holding and also examines effect of corporate diversification on value of cash holding in

good governance and bad governance firms; competitive and concentrated industries; family

and non-family firms and Shariah and non-Shariah compliance firms. The study revealed that

diversification reduces value of cash holding due to agency problem. Moreover, diversification

increase value of cash holding in good governed firms and reduces value of cash holding in

poor governed firms. Furthermore, external market discipline helps in mitigating agency

problem; therefore our result shows that diversification increase value of cash holding in

competitive industries. Similarly, family firms engage in corporate diversification for empire

building due to agency problems. Therefore, diversification reduced value of cash holding in

family firms. On the contrary, Shariah compliance is alternate for corporate governance (Ullah

& Rizwan, 2018) and alters the negative effect of corporate diversification on value of cash

holding. Therefore, diversification adds to value of cash holding in Shariah compliant firms.

5.1 Practical Implications

The study has several practical implications

• The study has implication for policy makers to promote corporate governance within

firm because due to corporate governance misallocation of cash is minimized and

ultimately increase firm value.

171

• The study will help investors and especially minority investors to invest in those firms

whom corporate governance is good because due to good governance their interest is

protected from expropriation of controlling share holders

• This study suggest policy makers to improve competition in product market because due

to competition agency problem is minimizes and have complementary role for corporate

governance in Pakistan

• The study will make investors aware about the importance of corporate governance in

family firms because corporate governance increase firm value in family firms. The

study also suggest that minority shareholders should invest in those family firms whose

corporate governance is good

• The study will help to policy makers to promote Shariah compliance in Pakistan

because agency problem is quietly low in Shariah compliant firms, and Shariah

compliance resolve agency problem.

• Firms involve in diversification reduces value of cash of cash holding due to agency

problem. This study will give insight to policy makers to improve firm level governance

that diversification does not harm firm value.

5.2 Limitation

The limitation of the study is that it investigated effect of corporate governance on

different facets of cash management i-e level of cash holding, value of cash holding, utilization

of excess, and performance only in Pakistani context. The structure of corporate governance is

quite different between developed and developing economies. The current study only used one

proxy for corporate governance index due to unavailability of data in Pakistan. The study

extensively investigated role of product market competition, family ownership, Shariah

172

compliance on relationship of corporate governance with different facets of cash management

but the study has limitation that it is only conducted in Pakistani context. Furthermore, the study

has limitation that it only measure product market competition through HHI index. The current

study investigated effect of corporate diversification on value of cash holding and found that

diversification reduces value of cash holding due to agency problem. The study has still

limitation that it only investigated the relationship of diversification and value of cash holding

in context of agency theory and only investigated the relationship in Pakistani context .

5.3 Future direction

The current study suggests some direction for future research. The study should conduct

in future to compare the effect of corporate governance on different facets of cash management

i-e, level of cash holding, value of cash holding, utilization of excess cash and performance in

developed and developing economies. The governance structure and degree of implementation

of corporate governance codes is different between developed and developing economies. The

future study should conduct role of import and export tariffs on corporate governance with

different facets of cash management. The change in import and export tariffs increase or

decrease competition in product market in particular economy. Moreover, Lerner index is also

measure of product market competition at firm level. Therefore, in future the research should

conduct to measure product market competition with HHI index as well with Lerner index to

provide more generalizability.

The current study checked effect of corporate governance on level of cash holding, value

of cash holding, spending of excess cash and performance in family firms. Future research

should conduct to check the effect of corporate governance on different facets of cash in those

173

family firms where founder exist and in those family firms where business transfer to next

generation and then compare the results. Furthermore, Shariah compliance is new concept more

research should conduct using multiple countries data on effect of corporate governance with

different cash policies in Shariah compliant firms. Another direction of this dissertation for

future research is to investigate effect of diversification on value of cash holding in developed

and developing economies and also provide another explanation beside agency theory.

174

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Appendix 1

In this section we estimated excess cash which is measured the difference between

normal cash of each firm at particular year and predicted cash of each firm at particular year.

Predicted cash is the residual cash measured from regression. The variables for regression are

inspired from the work of (Opler et al., 1999). Fama and Macbeth (1973) model is used to

measure excess cash. Fama and Machbeth model is cross-sectional regression that measure

regression on each year. The advantage to measure excess cash through Fama and Macbeth

(1973) model is that serial correlation is normally eliminated. The residual of the following

regression is used as predicted excess cash in the dissertation.

+��ℎ ℎ��*A =∝ +EF��1A + EG I��;A + EK�;A

+EN�1�A + EP��A + EQ ��A + ER��;A + ER��=A + �A

Cflow=stands for cashflow of company “i” at time “t”

Indcv=stands for industry adjusted cash flow volatility

Lev=stands for leverage of company “i” at time “t”

Nwc= stands for net working capital of company “i” at time “t”

Size= size of company “i” at time “t”

Mtob= market to book ratio of company “i” at time “t”

Div=1 for dividend payment and 0 for no payment of particular company “i” at time “t”

Capex= capital expenditure of company “i” at time “

195

Table 4.13: Determinants of cash holding

Fama-

MacBeth

cash Coef. Std. Err. t

cflow 0.661 0.200 3.3

indcv 0.787 0.305 2.58

lev -1.116 0.177 -6.29

nwc -0.387 0.087 -4.47

capex -0.343 0.159 -2.15

size 0.024 0.012 1.92

div 0.164 0.040 4.08

mtob 0.461 0.056 8.28

cons -1.744 0.123 -14.22

f-

pvalue 0.000

AvgR2 0.306

Result shows that cflow has positive and significant effect on cash: one unit increase in

cash flow increases cash by 0.679. This result is supported by Opler et al., (1999). Indcv shows

positive and significant effect on cash because as industry cash flow volatility increases cash

holding of firms is also increases. This result is supported by precautionary motive because

firms hold cash to depend themselves from external shock. Leverage is substitute for cash as

leverage increases firm maintain less cash because leverage is substitute for cash and transaction

motive of cash is supported this relationship and net working capital also shows negative and

significant relationship with cash and this relationship is again supported by precautionary cash

196

model. Further, size of the firm shows positive and significant relationship with cash, means

that large firms hold high cash as compare to small firms. MtoB which measure investment

opportunity and this relationship is supported by speculative motive of cash because firm who

have high investment opportunities in the market and underinvestment problem may be arise

with insufficient cash. So, firms have high cash with investment opportunity in the market.

Dividend shows significant and positive relationship with cash as firms. Capex shows negative

and significant relationship with cash as firm internal investment increases measure by capex

company level of cash decreases. All variables signs and significance is in line with the work of

(Opler et al., 1999; Dittmar & Mahrt-Smith, 2008)

197

Appendix2

Table 4.14: Effect of Competition Family ownership and Shariah Compliance on Total Factor

Productivity and operating profit

Tfp Indroa

cflow -0.250 *** -0.242 *** -0.238 *** 0.322 *** 0.346 *** 0.254 ***

(0.052) (0.052) (0.051) (0.031) (0.031) (0.030)

indcv 0.091 0.115 0.094 -0.166 *** -0.143 ** -.168 ***

(0.097) (0.097) (0.097) (0.058) (0.059) (0.055)

lev 0.097 *** 0.075 ** 0.097 *** 0.002 -0.023 0.059

(0.033) (0.032) (0.033) (0.019) (0.019) (0.018)

nwc 0.059 ** 0.049 * 0.065 ** 0.056 *** 0.031 * 0.119 **

(0.027) (0.027) (0.027) (0.016) (0.016) (0.016)

size 0.001 0.001 0.003 -0.004 ** -0.004 * -0.004

(0.004) (0.004) (0.004) (0.002) (0.002) (0.007)

mtob -0.030 ** -0.026 ** -0.027 ** 0.023 *** 0.033 *** -0.026 **

(0.012) (0.012) (0.012) (0.007) (0.007) (0.009)

excesst-1 0.004 ** 0.006 *** 0.003 * 0.004 *** 0.006 *** 0.004 ***

(0.002) (0.002) (0.002) (0.001) (0.001) (0.001)

excesst-1*com 0.659 *** 0.540 ***

(0.132) (0.078)

com -0.049 ** -0.019 *

(0.019) (0.011)

excesst-1*shariah 0.557 *** 0.193 **

(0.134) (0.081)

shr -0.042 *** 0.001

(0.013)

(0.008)

excesst-1*family 0.608 *** 0.408 ***

(0.131) (0.078)

family -0.031 ** -0.023 ***

(0.014) (0.007)

cons 0.986 *** 0.991 *** 0.936 *** 0.006 0.009 0.002

(0.066) (0.065) (0.066) (0.038) (0.039) (0.039)

198

F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000

R2 0.113 0.108 0.112 0.379 0.354 0.112

N 1077 1080 1080 1104 1107 1080

199

Appendix 3

This section provides table of 4.2 separately to provide more insight about the

relationship of corporate governance and cash holding. Furthermore, the role of product market

competition, family ownership and Shariah compliance in the relationship of corporate

governance and cash holding is also provided separately.

Table 4.15: Effect of corporate governance on cash holding

cash Coef. Std. Err. t P>t

Govindex -0.325 0.089 -3.630 0.000

cflow 0.908 0.238 3.820 0.000

indcv 0.926 0.439 2.110 0.035

mtob 0.380 0.036 10.550 0.000

size 0.015 0.012 1.230 0.221

lev -0.964 0.118 -8.140 0.000

nwc -0.405 0.111 -3.660 0.000

capex -0.327 0.187 -1.750 0.080

div 0.151 0.045 3.370 0.001

_cons -1.586 0.207 -7.650 0.000

Number of obs 1357 F-value 54.74

R-squared 0.268 Prob > F 0.000

Table 4.16: Effect of corporate governance on cash holding in competitive industries

Cash Coef. Std. Err. t P>t

Govindex 0.162 0.151 1.080 0.282

com 0.168 0.098 1.720 0.085 com*Govindex -0.523 0.178 -2.950 0.003

cflow 0.986 0.225 4.390 0.000

indcv 0.653 0.399 1.640 0.102

mtob 0.239 0.041 5.860 0.000

size -0.013 0.015 -0.870 0.382

lev -0.901 0.118 -7.620 0.000

nwc -0.422 0.104 -4.060 0.000

capex -0.280 0.171 -1.640 0.101

div 0.111 0.042 2.680 0.007

cons -0.770 0.275 -2.800 0.005

200

F-value

23.37 Prob > F 0.000

R-squared 0.428

Table 4.17: Effect of corporate governance on cash holding in family firms and Shariah

compliant firms

Cash Coef. S. E. t P>t Cash Coef. S.E. t P>t

Govindex 0.034 0.186 0.180 0.855 Govind -0.196 0.091 -2.150 0.032

family*Govindex -0.368 0.208 -1.770 0.077 shria 0.085 0.109 0.780 0.438

family -0.046 0.042 -1.090 0.277 sharia*Govind -0.107 0.214 -0.500 0.616

cflow 0.893 0.221 4.050 0.000 wcflow 0.998 0.234 4.270 0.000

indcv 0.657 0.420 1.560 0.118 windcv 0.670 0.410 1.630 0.103

mtob 0.241 0.044 5.520 0.000 wlnmtob 0.232 0.044 5.320 0.000

size -0.016 0.016 -0.990 0.321 wsize -0.013 0.016 -0.830 0.407

lev -0.908 0.127 -7.170 0.000 wlev -0.887 0.127 -7.000 0.000

nwc -0.434 0.107 -4.070 0.000 wnwc -0.410 0.107 -3.820 0.000

capex -0.269 0.174 -1.550 0.122 windcapex -0.278 0.175 -1.590 0.113

div 0.113 0.041 2.790 0.005 div 0.109 0.041 2.670 0.008

Cons -0.561 0.268 -2.090 0.037 _cons -0.670 0.273 -2.450 0.014

F( 42, 1313)

33.67

F( 41, 1314) 23.61 Prob > F

0.000

Prob > F

0.000

R-squared

0.425

R-squared 0.424

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