The Effect of Corporate Governance on Cash Holdings:
Evidence from Hong Kong
BY
WONG Ying Wai
09016031
Accounting Concentration
YANG Zhu
09050450
Accounting Concentration
An Honors Degree Project Submitted to the School of business in Partial Fulfillment of
the Graduation Requirement for the Degree of Bachelor of Business Administration
(Honors)
Hong Kong Baptist University
Hong Kong
April 2013
Supervisor: Dr. O. K. Kent Lee
Acknowledgement
We would like to express our utmost gratitude to our degree project supervisor, Dr. O. K.
Kent Lee for his precious and invaluable guidance and advice on our honors project. We
would like to thank him for his time and support and his care and mercifulness which
enlightened and stimulated us during our project.
We would also like to thank our friends and everyone who has helped and supported
through our research process.
Last but not least, we would like to thank our faculty, School of Business, for giving us
this chance to finish an honors degree project. We have gained valuable experience and
related academic knowledge, as well as to cooperate, and to balance in conducting this
research project.
WONG Ying Wai 09016031
YANG Zhu 09050450
1
Abstract
This study examines the effect of corporate governance on cash holdings by using 160
firm-year observations from 2010 to 2011 from Hong Kong listed companies. The
associate between corporate governance and the cash holdings depends on the size of
the firm. We measure corporate governance with ownership structure of executives and
board effectiveness. Small-sized firms with effective governance mechanisms are found
to have more intention to hold more cash. We document a negative relation between
CEO duality (CEO is the chairman) and cash holdings, and a positive relation between
CEO ownership and cash holdings.
Key word: Corporate governance, Cash holdings, Board of directors, CEO duality,
Ownership.
1. Introduction
It has always been a critical issue to decide an appropriate cash level in a company.
Cash provides liquidity to firms and is an important component of a firm’s assets. Firms
have the incentive to hold cash to ensure the operations, meet obligations, and catch the
good investment opportunities. Cash also acts as a buffer to prevent high opportunity
costs during cash shortage (Opler et al., 1999; Ozkan and Ozkan, 2004). Opler et al.,
(1999) suggest that companies with good investment opportunities and high cash flow
risks tend to hold more cash. The large amount of cash holding, however, may result in
agency problems of free cash flow as managers can get private benefits easily (Jensen,
1986). Weak governance mechanism further triggers managers to hold more cash,
which may cause unwise overinvestment like expensive acquisitions, and subsequently
have negative effect on the shareholders’ benefits (Dittmar et al., 2003; Jensen, 1986).
1.1 Statement of problems
Cash holding is a critical managerial decision to a company. In a perfect financial
market, there is no incentive for companies to hold substantial cash as they can transfer
2
assets to cash or get funded at a fair cost in the market immediately when they need
cash. However, the imperfect market because of transaction costs and asymmetric
information provides rationale for companies to reserve cash (Couderc, 2006).
Companies determine the optimal level of cash holdings though trading off costs and
benefits (Kim et al., 1998; Opler et al., 1999). The major two benefits of holding cash
stated by Keynes (1934) relate to the “transaction motive” and the “precautionary
motive”. Companies intend to hold cash in order to reduce the transaction costs of
financing and avoid disposal of assets due to a sudden need of cash. The second benefit
is to ensure companies to have profitable investment opportunities, instead of losing
investment interests due to the lack of cash holdings. Inefficient investment is resulted
from insufficient liquidity. The level of cash holdings is usually associated with growth
opportunities, investment levels, cash flow, research and development expenditure,
company size, leverage, working capitals, and dividend distribution (Kusnadi, 2011).
On the other hand, the conflict of interest may arise between management and
shareholders in the situation that a company hold large amount of cash (Jensen and
Meckling, 1976). The agency theory indicates that entrenched managers (company
executives) prefer to hoard cash rather than distribute dividends to shareholders as
turning cash into personal benefits is relatively easier than getting benefit from other
less liquid assets to managers (Myers and Rajan, 1998).
Dittmar et al. (2003) have also indicated that agency problem are an important
determinant of corporate cash holdings and a strong support has been showed from the
importance of corporate governance in determining cash holdings. Under an effective
corporate governance mechanism, i.e., shareholders’ rights are under good protection,
agency problems can be minimized, and managers can behave in the interests of
shareholders. On the contrary, weak governance, or poor protection for shareholders,
causes an entrenched management, under which the excessive cash is more like ly to be
held.
3
However, Harford et al. (2008) explain that companies with poor protection on
shareholders are relatively have small proportion of cash, as managers spend cash
quickly in unnecessary acquisition or investment to benefit themselves in a short term.
Studies have discussed the impact of country- level and company- lever corporate
governance on cash holdings for international firms. Dittmar et al. (2003) find
companies in weak external legal protection hold more cash as a result of the
entrenched management.
In Hong Kong, the external legal protection is strong, so the focus is on the corporate
level. Since prior studies have not examined the relationship of corporate governance
and cash policy in the Hong Kong environment, the availability of data on corporate
governance allows us to examine more in details.
1.2 Objectives of the study
This study is designed to examine the influence of corporate governance mechanisms
on the cash holdings of listed companies in Hong Kong.
- What is the impact of ownership structure on cash holdings level?
- What is the impact of board composition on cash holdings level?
After all, it is worth doing as little empirical studies on effect of corporate governance
on cash holdings have been conducted in Hong Kong. This study can contribute to the
limited literature in Hong Kong environment.
The following section of the paper conducts literature review on prior empirical and
theoretical studies; the third section develops hypothesis; followed by the methodology
and model design; the empirical results are discussed in the fifth section; and the last
section is our conclusion.
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2. Literature review
2.1 Agency problems and cash holdings
Jensen (1986) explained a positive relationship between free cash flow and agency
conflicts. After Opler et al. (1999) had examined several determinants of cash holdings
and specified a tradeoff theory including the impact of agency costs, studies focusing on
agency theory were widely conducted.
Harford et al. (2008) identified three hypotheses on the relationship between agency
cost and cash holdings. The flexibility hypothesis indicates that increase in agency cost
will result in a high level of cash holdings as managers prefer to hold the cash than to
distribute to shareholders. However, the spending hypothesis predicts highly
autonomous managers are willing to spend the excessive cash on hand on projects that
benefit them the most, and as a result, a low level of cash balance is caused.
Shareholder power hypothesis states if minority shareholders have effective control to
directors, they would allow mangers to hold excess cash to prevent underinvestment.
Dharmastuti and Wahyudi (2013) stated that the knowledge of corporate governance is
mainly derived from agency theory. Corporate governance is the mechanism to
scrutinize the contract between principals (shareholders) and agents (company
executives) (Demsetz, 1983; Fama, 1980). The separation of ownership and control
creates interest conflicts, which further cause information asymmetry and agency costs.
The evidence from Nikolov and Whited (2009) explained that governance is one of the
important factors that affect cash holdings.
2.2 Corporate governance
According to The Organization for Economic Co-operation and Development (OECD)
(1999), corporate governance is “the system by which business corporations are
directed and controlled”. Raithatha and Bapat (2012) had defined that corporate
governance is “overall control of activities in a corporation”.
Prior studies on the relationship between corporate governance and cash holdings had
5
controversial results. Dittmar et al. (2003) found that corporate governance affects the
level of cash holding using evidences from 45 countries. Specifically, manager prefers
to hold more cash in countries with poor shareholder protection. In contrast, Harford et
al. (2008) suggested that poor governance results in less cash holdings. However, Early
literatures found that the relationship between cash holdings and firm-level corporate
governance is not significant (Harford, 1999; Opler et al., 1999). Furthermore, Bates et
al. (2009) also concluded that high cash holdings are resulted from preventing high
risks of cash shortage, so that governance plays almost no roles in accumulating cash
reserves.
2.3 Ownership structure and board composition
Board of directors is an important component of corporate governance (Hill and Jones,
1992), especially in large business corporations (Fama and Jensen, 1983a; Williamson,
1983). They are responsible for monitoring the management of the CEO or directors, at
the same time to protect the benefits of shareholders. The internal governance is
commonly measured by the ownership structure, the composition of board members,
including chairman, directors and independent non-executive directors, and internal
auditing etc. (Ho, 2003). In addition, the quality of the governance, especially internal
mechanism, has a close relationship with corporate performance. (Aman and Nguyen,
2008).
The effect of corporate governance on cash holdings has been widely studied
worldwide. Ozkan and Ozkan (2004) investigated the impact of ownership structure to
cash holdings by using UK companies as a sample and expanded the evidence on a
non-monotonic relationship between firm ownership and cash holdings. In the
following part, literatures of different components to measure the corporate governance
are discussed.
2.3.1 Founder CEO
Previous studies showed a positive relationship between founder CEO and firm
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performance. Begley (1995) found that founder is CEO firms have a greater return on
assets than other firms. He (2008) had a similar result that founder-CEO firms have
higher financial performance under a dual leadership structure. These study suggested
that founder-CEOs’ interests are aligned with the company because of their stronger
organizational commitment. Therefore, according to the interest-alignment hypothesis,
shareholders tend to allow directors to accumulate cash and the relation between
founder-CEO and cash holdings is positive related (Chen and Chuang, 2009).
2.3.2 CEO ownership
Chen and Chuang (2009) pointed out that the interest alignment hypothesis is subjected
to the firms’ natures and the investment environment faced by firms. In this study, the
CEO with larger ownership in high-tech firms in US held more cash since the CEO
interest aligned with shareholders and in order to ensure sufficient cash for investment.
In contrast, most studies found a negative relationship between managerial ownership
and cash holdings because interest alignment effect lowers the agency costs, which
provides easier access of external financing due to low information asymmetry. Ozkan
and Ozkan (2004) found that the relationship between director ownership and cash
holdings is non- linear and suggested that the alignment effect of managerial ownership
out weight the entrenchment effect. Alignment effect indicates that the interest between
managers and shareholders are aligned when managers have greater ownership.
However, when the managerial ownership continues to increase, entrenchment effect
overwhelms and relationship between managerial ownership and cash holdings changes
to positive since the director dominates the board and hoard cash for self-interest.
2.3.3 CEO duality
According to Rechner and Dalton (1991), the CEO duality occurs when position of the
CEO and the chairman in the company are held by the same person. First on one side,
the duality creates a strong leadership; on the other side, duality declines the
effectiveness of monitoring the board (Finkelstein and D'Aveni, 1994).
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There were different results on the effect of CEO duality to corporate cash holding from
previous studies. Gill and Shah (2012) studied 166 Canadian listed companies from
2008 to 2010. They found that cash holding is positively affected by CEO duality. One
possible reason is that the CEO/Chairman does not act for the best interests of
shareholders. Research from Drobetz and Grüninger (2007) investigating 156 Swiss
non-financial firms from 1995 to 2004 also concluded the similar result. In contrast,
study documented that duality leads to insider dominance that is similar to family
control (Chen et al., 2005). Under agency theory, ineffective monitoring of board is one
of the reasons for poor governance since there is little monitoring on managers and it is
hard to fire poor performance directors (Carver, 2006). Prior literatures suggest CEO
duality seems to be less effective in corporate governance. Corporate with poor
governance hold less cash as directors spend cash quickly (Harford, 1999). The
underlying reason is found in Dittmar and Mahrt-Smith (2007)’s study that excess cash
holdings decrease the incentive to control cost or improve profit margins, and results in
overinvestment in low margin projects.
On the other hand, Rechner and Dalton (1991) found that there is a negative
relationship between company performance and duality. Meanwhile, other studies
indicated that there is no relation between firm performance and CEO duality (Chaganti
et al., 1985; Daily and Dalton, 1992).
2.3.4 Board size
Many studies suggested that company’s performance is better when the board size is
smaller (Lipton and Lorsch, 1992; Eisenberg, Sundgren and Wells, 1998; Hermalin and
Weisbach, 2003; Andres, Azorfra and Lopez, 2005). The reason is that decision making
process is more effective in a small board (Yermack, 1996); Lipton and Lorsch, 1992).
Gill and Shah (2012) and Kusnadi (2004) indicated that larger board size company has
more cash holdings. In contrast, Mak and Li (2001) , Kula (2005), and Drobetz and
Grüninger (2007) documented that board size has no significant effect on corporate
performance.
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2.3.5 Independent director
Studies suggested that independent directors can be an effective monitor to the board.
Kesner and Dalton (1986) found that outside director is more independent since close
relationship do not exist between management team and outsider director. As a result,
outside directors perform a better control and monitor function. Weisbach (1988), and
Huson, Parrino and Starks (2001) found bad performance manager is likely to be
resigned if independent directors take a major seats in the board. According to agency
theory, it is expected that non-executive director dominate board are likely to reduce
agency cost and hence hold less amount of cash (Ozkan and Ozkan, 2004). However,
Chen and Chuang (2009) found a positive relation between outside director and cash
holdings since the nature of high-tech firms requires them to hold more cash for future
investment.
According to Chapter 3 of Hong Kong Listing Rule1, every board should have at least 3
independent non-executive directors.
3. Hypothesis development
This study examines whether and how corporate governance affects the cash holding in
Hong Kong listed companies. As discussed above, prior literatures propose different
opinions on the effect of corporate governance on cash holdings. Some supported
effective governance is positively related to cash, while some argued that it has negative
effect on cash holdings.
The ownership structure and board attributes influence the board effectiveness and the
quality of corporate government. Based on previous literatures, we developed the
following hypotheses to test the effect of corporate governance on cash holdings by
dividing into individual components of corporate governance. The ownership structure
(i.e. Founder CEO, CEO duality, CEO ownership, Chairman ownership, and
1 See HK Listing Rules, Chapter 3:
http://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_3.pdf
http://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_3.pdf
9
non-executive directors ownership) and board attributes (i.e. proportion of independent
directors and board size)
H1: The presence of founder CEO affects cash holdings positively.
H2: The presence of CEO duality either positively or negatively affects cash holdings.
H3: CEO ownership is either positively or negatively associated with cash holdings.
H4: Chairman ownership is either positively or negatively associated with cash
holdings.
H5: Non-executive director ownership is negatively.
H6: Proportion of independent directors have in board is either positively or negatively
associated with cash holdings
H7: Board size affects cash holdings positively.
4. Empirical design
4.1 Research methodology
The theoretical model of this empirical study follows the generalized method of
moment (GMM) estimation procedure from Ozkan and Ozkan (2004) to eases off the
endogenous problems, since factors determine the cash holdings affect some of the
firm-specific characteristics such as leverage simultaneously, and the effects of the
determinants are often delayed to cash in next period. This model is employed by Chen
and Chuang (2009) and Kuan et al. (2011) to investigate the determinants of cash
holdings in American and Taiwan firms. Our study examines both ownership structures
and board attributes as corporate governance proxies, as well as corporate specific
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control factors, to test whether these variables are significantly associated with a firm’s
corporate cash policy following the GMM model.
4.2 Variables (Appendix A)
Subject to data availability and characteristic of Hong Kong companies such as family
business and chair duality, we modified some of the variables in the study of Chen and
Chuang (2008) on corporate governance and cash holdings in growing high- tech firms
listed on NASDAQ. The dependent variable, Cash holdings, is the ratio o f cash or cash
equivalent to total assets.
4.2.1 Governance variables
Under ownership structure variables, we design a Founder dummy to check the impact
of founders in board, which includes situations where the founder is also the CEO or the
chairman in board, or a family of the two. CEOChair dummy is modified to combine
the situation of chair duality and where CEO and chairman are families. The share
ownership of CEO, the chairman and non-executive directors are denoted with
CEOOwn, ChairOwn, and NEDOwn. The shareholding of non-executive directors
measures the independency of the board (Chen and Chuang, 2009).
Board attributes are proxied by two variables, Board size (BODSize) and Independent
Directors Proportion (IndependDir). Companies with large board size have relatively
poor corporate governance (Hellman and Puri, 2000; Yermack, 1996). And outside
directors enhance the effectiveness of the board in management monitoring and
shareholders protection (Core et al., 1999). According to Hong Kong Listing Rules
Ch.32, the independence is assessed by not more than 1% of company’s total issued
capital, financial independent to the company, including its related parties, and not
connected with any current or former executives in the company.
2 See HK Listing Rules, Chapter 3:
http://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_3.pdf
http://www.hkex.com.hk/eng/rulesreg/listrules/mbrules/documents/chapter_3.pdf
11
4.2.2 Firm-specific control variables
Variables related to firm’s cash level are considered. Leverage, the ratio of total debts to
total assets, measures a company’s financial risk, is expected to negatively associate
with cash holdings as large cash reserves lower the risk of default and thus reduce the
financial risks, Capital expenses (Capex to total assets ratio), and R&D expenses (R&D
to total assets ratio) are expected to be positively related to cash holdings as implied by
Dittmar et al. (2003) and Boyle and Guthrie (2003) that companies have great
investment opportunities prefer to reserve more cash since sufficient internal cash
holdings help to prevent foregoing potential investment opportunities. Conversely, the
pecking order theory indicates substantial capex drains out the cash of a firm (Daher,
2010). Negative relationship between Capex and cash holdings is found by Bates et al.
(2009) and Lee and Song (2007). Prior studies also show that net working capital
(working capital net of cash to total assets ratio) is negatively related to cash holdings
(Bates et al., 2009; Ferreira and Vilela, 2004; Tong, 2006; Lee and Song, 2007). This is
supported by the trade-off theory that networking capitals can be converted to cash
easily. The firm size (Size, logarithm of total assets) is positively related to cash holding
as indicated by Kalcheva and Lins (2007) and Ozkan and Ozkan (2004). Normally,
larger firms intend to hold reserve more cash to maintain the high level and quality of
operations and investment chances. On the other hand, a number of studies find an
opposite result (Daher, 2010; Drobetz and Grüninger, 2007; Nguyen, 2006) based on
the tradeoff theory as large firms benefit from economies of scale, easier access of
financing with lower costs (Ferri and Jones, 1979).
4.3 Models development
4.3.1 Impact of company ownership structure
CASHit = β0 + β1FOUNDERit +β2CEO_CHAIRit + β3CEOOWNit + β4CHAIROWNi t +
β5NEDOWNit + ∑δnCONTROLit + εit
Where i denotes firm i and t denotes time t. CONTROL denotes the following
financial variables: Cash(t-1), Leverage, NWC, Div Dummy, CapExp, R&D, and Size.
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With this regression equation, our hypotheses can be expressed in terms of the expected
signs of the coefficient estimates.
H1 β1=0, against the alternative β1
13
c. were controlled by Mainland Government entities or individuals (i.e H-shares
companies4, Red Chip companies5)
d. were under the Financial sector (Hang Seng Industry Classification System
(HSICS) code: 50)
e. were non-ordinary shares or companies lack of available data
We exclude 139 H-shares companies 6 and 102 Red Chip companies 7 in order to
eliminate the heavy effect of Chinese government on the their corporate governance as
most of these companies are state-owned enterprises (SOEs), i.e. the ultimate
shareholder is the central or local government in China. However, our sample includes
Mainland private enterprises which are incorporated outside of the Mainland and are
controlled by Mainland individuals. We consider the government influence on these
companies is minimized.
Similar to previous studies, banks (Code: 501) and insurance companies (Code: 502)
are excluded as a result of different cash holdings requirement to ensure liquidity.
In the population of 925 companies, we randomly select 80 companies through MS
Excel, and replace companies if one is lack of information. The fina l sample consists of
160 firm-year observations covered from year 2010 to 2011. Table 1 shows the
screening process.
4 H-share companies are enterprises that are incorporated in the Mainland which are either controlled
by Mainland Government entities or individuals 5 Red chip companies are enterprises that are incorporated outside of the Mainland and are controlled
by Mainland Government entities 6 H-share companies l ist is disclosed on the China Security Regulation Commission ’s web:
http://www.csrc.gov.cn/pub/csrc_en/affairs/OverseasListing/OverseasListedCompanies/201203/t2012
0331_208037.htm 7 Red Chips companies l ist is disclosed on
http://www.hkex.com.hk/eng/stat/smstat/chidimen/cd_rcmb.htm
http://www.csrc.gov.cn/pub/csrc_en/affairs/OverseasListing/OverseasListedCompanies/201203/t20120331_208037.htmhttp://www.csrc.gov.cn/pub/csrc_en/affairs/OverseasListing/OverseasListedCompanies/201203/t20120331_208037.htmhttp://www.hkex.com.hk/eng/stat/smstat/chidimen/cd_rcmb.htm
14
Table 1- Summary of Sample Companies Selection Process
Total listed companies on HKEx on 21 Dec 2011 1,510
Less companies listed on GEM Board in 2011 (173)
Less companies that:
New listed (76)
Delisted (9)
As foreign companies (17)
H-shares companies (133)8
Red Chips companies (101)9
Financial companies (74)
Preferred shares or B-Class shares (2)
Total qualified population companies 925
The full list of the sample companies is in Appendix B
Governance variables are hand collected from companies’ annual reports available on
website of HKEx10. According to Part XV of Securities and Futures Ordinance 11 (SFO),
Directors and chief executives of a listed corporation must disclose their interests, and
short positions, in any shares in a listed corporation (or any of its associated
corporations) and their interests in any debentures of the listed corporation (or any of its
associated corporations). We calculated the ownership of CEOs, chairs, and
non-executive directors as beneficial ownership, instead of deem interests12 disclosed
in annual report.
Firm-specific control variables are calculated using financial data including total assets,
cash, long-term debts, net working capital, capital expenses, R&D expensed, and
common dividend payments collected from Datasteam.
4.4.2 Company Statistics
8 5 new listed and 1 delisted during 2011 have been counted.
9 1 new listed has been counted.
10 See http://www.hkexnews.hk/listedco/listconews/advancedsearch/search_active_main.aspx
11 See http://www.sfc.hk/web/EN/rule-book/sfo-part-xv-disclosure-of-interests/
12 Deem interests defined under Part XV of SFO (CAP. 571 S3.5)
http://en-rules.sfc.hk/en/display/display_main.html?rbid=3527&element_id=3007
http://www.hkexnews.hk/listedco/listconews/advancedsearch/search_active_main.aspxhttp://www.sfc.hk/web/EN/rule-book/sfo-part-xv-disclosure-of-interests/http://en-rules.sfc.hk/en/display/display_main.html?rbid=3527&element_id=3007
15
Our sample covers all the industries based on HSICS (no financial sector). Consumer
Goods Sector covers most of the companies at 36.3%, followed by Properties &
Construction, Services, and Industrial Goods with over 10%. These are in line with the
industry distribution of Hong Kong market13.
Table 2- Industry Classification
HSICS Code Industry Number of firms Percentage
(%)
00 Energy 2 1.5
05 Materials 8 10.0
10 Industrial Goods 9 11.3
20 Consumer Goods 29 36.3
30 Services 11 13.8
35 Telecommunications 2 2.5
40 Utilities 1 1.3
50 Financials - -
60 Properties & Construction 12 15
70 Information Technology 5 6.3
80 Conglomerates 1 1.4
A total of 80 samples are included over the 2010-2011 periods. Industry classification
is based on Hang Seng Industry Classification System (HSICS).
The total market capitalization (market cap.) of the sample listed companies is HKD
336,518.88 million; it counts only 1.93 % of the total market cap. of listed companies
on the Main Board. This results from the exclusion of H-shares and Red Chips, which
consist of 23.47% and 21.91% of the equity market in the year of 201114.
The mean market cap. is HKD 3,756.13 million and the median market cap. is HKD
751.31 million. Comparing to the constituents of Hang Seng Composite Small Cap
Index (HSSI), we identify our sample companies substantially smaller, and as small size
13
“News release: HKEx Adopts Hang Seng Industry Classification System” (2007) http://202.66.146.82/regbod/hk/hkex/press/p071211a.pdf
14 http://www.hkex.com.hk/eng/stat/statrpt/factbook/factbook2011/Documents/FB_2011.pdf
http://202.66.146.82/regbod/hk/hkex/press/p071211a.pdfhttp://www.hkex.com.hk/eng/stat/statrpt/factbook/factbook2011/Documents/FB_2011.pdf
16
companies on average, showing in Table 3.
Table 3- Company Market Cap Comparison
(HKD in thousands) Sample Companies HHSI Constituents15
Mean Market Cap. 4,206,486 8,265,418
Median Market Cap. 751,305 5,646,835
The HHSI represent the bottom 5% of total market capitalization of Hang Seng
Composite Index, which covers about 95% of the total market capitalization of stocks
listed on the Main Board of the HKEx16.
5. Results and Discussion
5.1 Descriptive Statistics
Table 4 shows the descriptive statistics of all the variables. The companies’ cash
consists of 26.54% of total assets on average. This figure is lower than that of the Chen
and Chuang (2009)’s study on high-tech firms in America which is 34.6%. It can be
explained by the fact that high-tech companies with high growing rate face a strong
competition environment (Carpenter and Petersen, 2002) and thus tend to hold more
cash for future investment opportunities (Chen and Chuang, 2009). Our finding
indicates a similar result with Lee and Song (2012)’s study of East Asian firms
including 536 Hong Kong companies in 2005, with the mean cash holdings of 21.3%.
The mean founder dummy of our sample is 51.0%. This reveals around half of sample
listed companies have a founder related to the top managers. In addition, 60.0% of the
board chairmen and CEOs are the same person on average, which is not highlighted in
the US environment. In terms of ownership structure, the CEO owns 19.0% shares of
the company while chairman has a higher shareholding of 27.3%. This is similar to the
15
Constituents ’ market caps are collected from Datastream. Currency denoted in Chinese Yuan (CNY) is
expressed in HKD with the HKD/CNY exchange rate of 1.2339 on 30 Dec 2011 from Bloomberg. 16
See Benchmark Indexes http://www.hsi.com.hk/HSI-Net/static/revamp/contents/en/dl_centre/brochures/hsci_E.pdf
http://www.hsi.com.hk/HSI-Net/static/revamp/contents/en/dl_centre/brochures/hsci_E.pdf
17
results Brickley et al. (1997) found in the US companies that 8 out 11 firms’ chairmen
have a higher ownership than the CEOs. Non-executive directors, however, have only
2.0% of ownership, which is substantially lower than that in the US high-tech firms
with 9.9%.
There are 8.2 directors in a board in general. With the mean proportion of independent
directors of 41.2%, the number of independent directors in our sample companies
counts 3.38. This is only a little higher than the 3 independent non-executive directors
as minimum requirement according to the Hong Kong Listing Rules.
The mean financial leverage tells that the long-term debts count 7.7% of total assets in
the company. The working capital net of cash is only 0.6% of total assets. Moreover, the
mean dividend dummy indicates 58% of our sample companies distribute dividends in
our study year. Capital expenditures consist 5.9% of total asset. Furthermore, R&D
expenses are only 0.8% of total assets, which is much lower than the 37.3% in the US
high-tech companies by Chen and Chuang (2009) due to different business model of
sample companies. R&D is crucial to high-tech firms to maintain competitive
advantages in the market, while in our sample IT companies count only 6.3%, the
majority of companies have little investments in R&D. The average size means the
logarithm of total assets is 6.3, which is higher than the 4.6 of the growing high-techs.
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Table 4- Descriptive Statistics
Variables (N=160) Mean Std.
Deviation
Maximum 75th
Percentiles
Median 25th
Percentiles
Minimum
Dependen variable
Cash holdings 26.5 18.6 96.5 36.5 24.3 11.8 0.7
Governance variables Founder Dummy 0.51 0.50 1.00 1.00 1.00 0.00 0.00
CEOChair Dummy 0.60 0.49 1.00 1.00 1.00 0.00 0.00
CEOOwn % 18.94 21.20 74.07 31.96 10.15 0.00 0.00
ChairOwn % 27.30 21.05 74.07 38.47 25.45 9.34 0.00
NEDOwn (%) 1.99 8.00 60.00 0.21 0.00 0.00 0.00
BODSize 8.18 2.25 18.00 9.00 8.00 7.00 5.00
LogBODSize 0.90 0.11 1.26 0.95 0.90 0.85 0.70
IndependDir (%) 41.23 8.94 60.00 44.44 42.86 33.33 20.00
Control variables
Leverage 7.68 15.78 117.48 9.12 0.98 0.00 0.00
NWC 0.58 24.05 57.75 14.25 1.76 -9.87 -172.64
Div Dummy 0.58 0.50 1.00 1.00 1.00 0.00 0.00
CapExp 5.95 11.36 125.01 7.07 2.89 0.80 0.00
R&D 0.77 2.93 30.00 0.12 0.00 0.00 0.00
Size 6.29 0.64 8.50 6.61 6.23 5.80 5.08
5.2 The impact of corporate governance on cash holdings
This study has three models specifications: model (1) examines the impact of ownership
structure; model (2) examines the effects of board variables; and model (3) combines all
variables. Table 5 exhibits the empirical results. The adjusted R square in Model
summary (Appendix D) shows 56% of the sample data are explained by our model (3).
The .000 significance (
19
Table 5- Impact of corporate governance on cash holdings
Beta (1) B Beta (2) B Beta (3) B
(Constant)
(40.872)
(33.068)
(36.701)
Cash(t-1) 0.624 (0.601)*** 0.663 (0.638)*** 0.628 (0.605)***
Governance variab les
FounderDummy 0.038 (1.419)
0.036 (1.35)
CEOChairDummy -0.163 (-6.155)** -0.167 (-6.313)**
CEOOwn % 0.171 (0.149)** 0.167 (0.146)**
ChairOwn % -0.027 (-0.023) -0.032 (-0.029)
NonExeDirOwn (%) -0.026 (-0.061) -0.028 (-0.064)
IndependDir (%) 0.034 (0.071) 0.037 (0.077)
LogBODSize -0.012 (-2.126) -0.007 (-1.149)
Control variab le
Leverage -0.08 (-0.094) -0.067 (-0.079) -0.085 (-0.1)
NWC -0.284 (-0.22)*** -0.271 (-0.209)*** -0.287 (-0.221)***
Div Dummy 0.093 (3.496) 0.092 (3.466) 0.096 (3.596)
CapExp -0.05 (-0.082) -0.042 (-0.068) -0.054 (-0.088)
R&D -0.018 (-0.112) -0.004 (-0.022) -0.008 (-0.05)
Size -0.167 (-4.832)*** -0.142 (-4.099)** -0.155 (-4.472)**
Significance at the 1% and 5% level is denoted by *** and ** respectively.
Our Hypothesis 2 is accepted at 5% significance level, there is significant and negative
effect of CEO duality on cash holdings. Companies that the CEO is also the chairman
or a family of the chairman tend to hold more cash. Previous study suggested that when
CEO and chairman is the same person, which is a single leadership structure, the board
would be less effective than dual leadership structure (Kusnadi, 2011). Firms with
boards that are large, headed by a chairman who also holds the CEO post, and
dominated by insiders tend to be less efficient. Consequently, these firms would be
expected to suffer from more severe agency problems and to have less effective
corporate governance. Dittmar et al. (2003) documented that firms in countries with
poor shareholder protection (which also implies poor governance) hold larger cash
balances. As a result, poor corporate governance indicates excess cash holdings. This is
in contrary to Ozkan and Ozkan (2004)’s finding that single leadership structured firms
hold more cash since our sample companies are smaller than those in other studies.
20
While this is in line with Chen and Chuang (2009)’s study, as similarities between their
sample of high-tech firms and ours.
Furthermore, other study supported our findings that good governance is associated
with relative excessive cash holdings (Liu and Chang, 2009). The possible explanation
for our empirical result is found in Harford et al. (2008). That study indicated that week
governance holds less cash is due to antitakeover provision. According to Faleye (2004),
proxy battle is extracted by poor governance with excess cash holdings. In order to
avoid losing position in the board, CEO tends hold less cash. Give the potential penalty
of accumulation liquidity, CEO has the incentive to spend cash quickly rather than hold
it (Harford et al., 2008).
Moreover, companies have chair duality issue more dividends than companies with split
roles do in our findings (Appendix C) 17 . One possible explanation is that the
shareholders are not able to monitor the director effectively when the board is ruled by
single director. The agency theory also supported that chair duality has negative effect
on corporate performance because the monitoring and control of CEO is compromised.
Therefore, firms have less cash holdings as CEO/chairman intends to pay more
dividends to maximize his personal benefit rather than considering the benefit of
shareholders in terms of long-term operation of the company.
On the other hand, positive relationship between the CEO ownership and cash holdings
is found. This supports our Hypothesis 3. When the ownership of CEO is higher, the
shareholder interests are likely in line with CEO interests. When shareholders’ interests
are well protected, they are more confident to allow corporate have more cash reserves.
The sufficient cash holding allows firms to catch potential investment opportunities,
especially to small size companies. Ozkan (1996) suggested that small companies are
easier to face liquidation problem during financial distress. Whited (1992) and Kim et al
17
We further test the positive relationship between Chairman duality and ratio of dividend to total assets. 5% significance exists.
21
(1998) further explained that small firms have higher cost of external financing and
borrowing constraints than larger firms. Opler et al. (1999) give evidence that small
firms hold larger cash. Thus an effective board acts on behalf of shareholders are
willing to ensure a high level of cash holdings.
In addition, our finding suggests that there is no significant relationship between
Founder CEO, chairman ownership, and non-executive director ownership to cash
holdings. H1, H4 and H5 are not supported.
For board attributes, we find that both board independence and board size are
insignificantly related to cash holdings, H6 and H7 are not accepted. This is inconsistent
with Chen and Chuang (2009) that the two variables are positively and significantly
related to cash holdings.
One possible explanation that no significant effect from proportion of independent
directors in board lies behind Chen et al. (2005)’s study on 412 public listed companies
in Hong Kong. It found that governance composition (i.e. proportion of independent
non-executive directors, outsider dominated the board) has little impact on firms’
performances, especially for small market cap firms. It is implies by the self-selection
basis in the selection process of outsider directors.
Literatures on the effectiveness of board size are mixed. Larger board size enhances the
monitoring, but rigidizes decision-making. Boone et al. (2007) found evidence
supporting Harris and Raviv (2008) predicted that larger boards provides optimal
monitoring when managers have opportunity to enjoy great private benefit. On contrast,
Yermack (1996) found that smaller boards are more efficient.
Therefore, it is uncertain whether the board attributes have effect on a firm’s cash
holdings.
22
5.3 The effect of founder relationships
In the sample, around half of founders sit in the board as the chairman, or involve in
management as the CEO, or have a close relationship as a family of the two. In the
other words, founders tend to have a great influence on decision making and business
operation. With great passion to the company they established initially, founders with
managerial influence are likely to act in the interest of a long-term benefit for the
company. This study analyzes the differences of effects that corporate governance has
on cash holdings between firms with an active executive founder and firms with the
leader teams have little relationship with the founder. By examining the interactions of
Founder dummy with other governance factors, we check the influence of a close
founder on the relation between corporate governance and cash holdings. Table 6 shows
the results that positive relationship of CEO ownership and negative effect of chair
duality follow the H2 and H3. However, no significance is found from the impact of a
close founder on enhancing the relation between corporate governance and cash
holdings.
23
Table 6- Impact of founder CEOs on the relation between corporate governance and
cash holdings
Beta B Beta B Beta B
(Constant)
(39.702)
(27.647)
(27.928)
Cash(t-1) 0.614 (0.592)*** 0.668 (0.644)*** 0.623 (0.6)***
Governance variab les
FounderDummy 0.035 (1.292) 0.001 (0.034) 0.038 (1.411)
CEOChairDummy -0.162 (-6.137)** -0.158 (-5.975)**
CEOOwn % 0.178 (0.156)** 0.158 (0.138)**
ChairOwn % -0.02 (-0.017) -0.02 (-0.017)
NonExeDirOwn (%) -0.046 (-0.107) -0.041 (-0.096)
IndependDir (%) 0.02 (0.042) 0.03 (0.062)
LogBODSize 0.009 (1.471) 0.014 (2.384)
Control variab le
Leverage -0.094 (-0.11) -0.062 (-0.073) -0.095 (-0.112)
NWC -0.285 (-0.22)*** -0.262 (-0.203)*** -0.269 (-0.208)***
Div Dummy 0.083 (3.102) 0.081 (3.05) 0.069 (2.597)
CapExp -0.054 (-0.088) -0.031 (-0.051) -0.054 (-0.088)
R&D -0.022 (-0.14) 0.002 (0.015) -0.003 (-0.021)
Size -0.161 (-4.644)*** -0.123 (-3.546)* -0.12 (-3.475)*
FdummyCEOChair 0.071 (1.404) 0.083 (1.644)
FdummyCEOOwn 0.008 (0.15) 0.029 (0.542)
FdummyChairOwn -0.032 (-0.597) -0.023 (-0.425)
FdummyNEDOwn -0.04 (-0.741) -0.02 (-0.368)
FdummyIndpendDir -0.085 (-1.585) -0.099 (-1.84)
FdummyLogBODSize 0.021 (0.388) 0.027 (0.508)
5.4 Effect of firm characteristics
The cash holdings are perfectly and positively related to that in prior year. In addition,
working capital net of cash is perfectly and negatively affects the cash holdings. This is
consistent to prior studies and is explained by trade off theory with the high liquidity of
working capital. Meanwhile, firm size is negatively related to cash holding at 5%
significance level. Tradeoff theory is applied as large firms benefit from economies of
scale, easier access of financing with lower costs. Small companies have the intention
to hold more cash. This implies that the small-sized sample companies with good
corporate governance have a higher cash level.
24
However, leverage, capital expenses, R&D expenses, and the decision of whether to pay
dividends have no significant influence on cash holdings in small size firms.
6. Conclusion
In this study, we analyze a sample of 80 listed Hong Kong companies for two years
from 2010 to 2011, and examine the effect of effective corporate governance on cash
holdings in Hong Kong. We develop three models in the first group. The first model
tests the impact of ownership structure, as a measurement of corporate governance, on
cash holdings. The second examines the impact of board attributes on cash holdings.
And the third combines all variable to test the effect on cash holdings. The other group
of models further reviews the influence of funder CEOs on the relation between
corporate governance and cash holdings.
The random selected sample consists of small-sized firms. And the empirical analysis
shows a negative relationship between CEO duality and cash holdings; while CEO
ownership positively affects cash holdings. Separate of CEO and the chairman
improved the board effectiveness. Higher CEO ownership aligns the shareholders
interests with the managers. Both factors reflect effective corporate governance. The
results from the small-sized listed companies in Hong Kong are in line with Chen and
Chuang (2009)’s study on growing high- tech companies that a corporate cash level and
governance effectiveness is positively related. Small-sized firms prefer to hold more
cash to avoid underinvestment and the potential consequence of being acquired due to
proxy fight.
In conclusion, our results suggest that effective corporate governance has a positive
effect on cash holdings in small firms. Further research need to be done in order to
inspect the different effects of corporate governance on cash holdings associate with
firms in different sizes.
25
Appendix
Appendix A- Definitions of variables
Name Description
Dependent variables
Cash holdings Ratio of cash and cash equivalents to total assets
Independent variables
Governance variables
Founder dummy Dummy variable = 1 if the Founder is the CEO or the
Chairman or a family of the two
ChairCEO dummy Dummy variable = 1 if Chairman of company is the
company’s CEO or a family of the CEO
CEOOwn (%) Percentage of shares owned by CEOs
ChairOwn (%) Percentage of shares owned by the Chair
NonExeDirOwn (%) Percentage of shares owned by non-executive directors
BODSize Total number of directors on a firm’s board
Log (BODSize)
IndependDir (%) Proportion of independent non-executive directors on
the board
Control variables
Leverage (%) Ratio of long-term debt to total assets
R&D (%) Ratio of R&D expenses to total assets
NWC (%) Ratio Working capital net of cash to total assets
Size The logarithm of total assets
Div dummy Dummy variable = 1 if a company pays dividend in a
given year
26
Appendix B- Sample Company List
Stock
Code Company Name Market Cap.
HSICS
Code
4 Wharf (Holdings) Ltd. 106,326,581,178 800
293 Cathay Pacific Airways Ltd. 52,398,809,699 304
3333 Evergrande Real Estate Group Ltd. 47,956,999,160 601
220 Uni-President China Holdings Ltd. 16,737,419,250 204
1333 China Zhongwang Holdings Ltd. 14,380,775,024 52
2314 Lee & Man Paper Manufacturing Ltd. 11,770,953,680 53
1882 Haitian International Holdings Ltd. 10,661,280,000 100
818 Hi Sun Technology (China) Ltd. 5,667,671,250 702
1308 SITC International Holdings Co. Ltd. 5,200,000,000 304
468 Greatview Aseptic Packaging Co. Ltd. 3,467,360,000 204
266 Tian Teck Land Ltd. 2,967,073,900 601
2010 Real Nutriceutical Group Ltd. 2,855,269,880 205
878 Soundwill Holdings Ltd. 2,392,013,975 601
78 Regal Hotels International Holdings
Ltd. 2,353,333,083 302
1168 Sinolink Worldwide Holdings Ltd. 2,053,845,443 601
398 Oriental Watch Holdings Ltd. 2,031,372,397 301
926 Besunyen Holdings Co. Ltd. 1,971,132,719 205
1328 International Elite Ltd. 1,968,083,000 305
1863 Sijia Group Co. Ltd. 1,864,869,750 53
801 Golden Meditech Holdings Ltd. 1,760,536,811 205
2118 Tian Shan Development (Holding) Ltd. 1,740,000,000 601
752 Pico Far East Holdings Ltd. 1,685,561,405 305
996 Oriental Ginza Holdings Ltd. 1,604,584,152 601
1388 Embry Holdings Ltd. 1,603,908,150 203
197 Heng Tai Consumables Group Ltd. 1,454,766,904 204
3838 China Starch Holdings Ltd. 1,392,902,880 53
64 Get Nice Holdings Ltd. 1,342,042,788 302
3999 DaChan Food (Asia) Ltd. 1,336,414,200 204
3889 Global Sweeteners Holdings Ltd. 1,237,344,660 204
367 Chuang's Consortium International Ltd. 1,169,091,264 601
539 Victory City International Holdings Ltd. 1,133,382,865 203
340 China Mining Resources Group Ltd. 1,032,682,390 52
1161 Water Oasis Group Ltd. 932,022,372 301
837 Carpenter Tan Holdings Ltd. 925,000,000 202
889 Datronix Holdings Ltd. 915,200,000 100
676 Pegasus International Holdings Ltd. 898,761,000 203
106 Shenzhen High-Tech Holdings Ltd. 854,240,605 601
600 China Infrastructure Investment Ltd. 853,982,102 601
27
1155 Centron Telecom International Holding
Ltd. 848,991,825 350
526 Lisi Group (Holdings) Ltd. 755,473,957 202
686 Goldpoly New Energy Holdings Ltd. 747,136,492 203
1039 Changfeng Axle (China) Co. Ltd. 736,000,000 100
1170 Kingmaker Footwear Holdings Ltd. 724,722,711 203
3318 China Flavors and Fragrances Co. Ltd. 687,654,814 204
1020 Sinoref Holdings Ltd. 660,000,000 100
261 CCT Tech International Ltd. 654,139,940 701
550 Cinderella Media Group Ltd. 641,184,000 303
92 Champion Technology Holdings Ltd. 619,453,376 702
1123 China-Hongkong Photo Products
Holdings Ltd. 616,829,040 202
1188 Hybrid Kinetic Group Ltd. 614,221,420 201
130 Moiselle International Holdings Ltd. 581,187,800 203
2188 China Titans Energy Technology Group
Co. Ltd. 564,400,000 100
1225 Lerado Group (Holding) Co. Ltd. 532,905,214 202
33 Rainbow Brothers Holdings Ltd. 517,302,500 202
216 Chinney Investments, Ltd. 490,717,656 601
508 Chevalier Pacific Holdings Ltd. 475,019,034 204
1399 Scud Group Ltd. 469,560,567 202
595 AV Concept Holdings Ltd. 425,792,093 703
1195 Kingwell Group Ltd. 423,560,620 100
646 China Environmental Technology
Holdings Ltd. 410,835,786 400
1222 Wang On Group Ltd. 404,545,971 601
223 Sino Resources Group Ltd. 348,578,845 2
1682 Ford Glory Group Holdings Ltd. 328,500,000 203
396 Hing Lee (HK) Holdings Ltd. 302,998,344 202
834 China Kangda Food Co. Ltd. 298,734,120 204
922 China Boon Holdings Ltd. 297,451,561 305
841 Asia Cassava Resources Holdings Ltd. 252,000,000 53
1073 China Agrotech Holdings Ltd. 242,329,565 53
370 China Best Group Holding Ltd. 216,418,705 2
601 Group Sense (International) Ltd. 200,009,726 202
464 Kenford Group Holdings Ltd. 197,516,700 202
2323 Topsearch International (Holdings) Ltd. 190,386,000 100
640 Infinity Chemical Holdings Co. Ltd. 190,000,000 53
679 Asia Tele-Net And Technology
Corporation Ltd. 164,188,409 100
524 e-Kong Group Ltd. 161,510,000 350
565 Art Textile Technology International 157,130,990 203
28
Co. Ltd.
243 QPL International Holdings Ltd. 141,964,107 703
567 Daisho Microline Holdings Ltd. 136,869,479 100
650 Shun Cheong Holdings Ltd. 131,983,880 302
736 China Properties Investment Holdings
Ltd. 61,402,582 601
Appendix C- regression result on testing linear relationship between Div/TA and
Chair duality
Coefficientsa
Model
Unstandardized Coefficients
Standardized
Coefficients
t Sig. B Std. Error Beta
(Constant) .006 .008 .768 .444
CEOChairDummy .021 .011 .155 1.974 .050
a. Dependent Variable: Div/Total Assets
The 5% significance level demonstrates the existence of chair duality increase the
dividend pay. This demonstrates a lower cash level after higher dividend payment in
firms with chair duality.
Appendix D- Model Summary (combined model)
CASHit = β0 + β1FOUNDERit +β2CEO_CHAIRit + β3CEOOWNit + β4CHAIROWNi t +
β5NEDOWNit +β6INDit +β7LogBOARDit + ∑δnCONTROLit + εit
Model Summaryb
N R R Square Adjusted R Square Std. Error of the Estimate
160 .774a .599 .560 12.316
Appendix E
ANOVAb
Model Sum of Squares df Mean Square F Sig.
Regression 32798.071 14 2342.719 15.446 .000a
Residual 21992.893 145 151.675
Total 54790.964 159
29
a. Predictors: (Constant), Cash(t-1), FounderDummy, CEOChairDummy, CEOOwn %, ChairOwn
%, NonExeDirOwn (%), IndependDir (%), LogBODSize, Leverage, NWC, Div Dummy, CapExp,
R&D,,Size,
b. Dependent Variable: Cashholdings
Appendix F
30
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