International Business and Accounting Research Journal

Volume 4, Issue 2, July 2020, 71-80

http://ibarj.com

Examining The Excess Cash Holdings As An Indicator of Agency Prob-

lems

Ernie Hendrawaty

DOI: http://dx.doi.org/10.15294/ibarj.v4i2.125

Department of Management, Faculty of Economics and Business, Universitas Lampung, Indonesia

Info Articles Abstract

____________________ ___________________________________________________________________
History Articles: This research aims to examine the implications of excess cash holdings on firm value based on
Submitted 23 March 2020 agency theory. Data were obtained from a total sample of 1828 non-financial public companies in
Revised 15 May 2020 Indonesia, with 672 exceeding normal cash holdings using the panel regression techniques. The
Accepted 3 July 2020 result showed that excess cash holdings have a negative effect on the firm value which is stronger
____________________ for more concentrated ownership, for more dispersed ownership and for more financially difficult
Keywords: firms. Overall the empirical finding showed that excess cash holdings acts as a significant indicator
agency problem; of agency problems.
agency theory;
excess cash holding
_________________________

Address Correspondence: p-ISSN 2550-0368
E-mail: ernie.hendrawaty@feb.unila.ac.id
e-ISSN 2549-0303

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INTRODUCTION

Theoretically, company managers need to invest in unprofitable projects. A decrease in

properly allocate cash holdings to maximize the market value shows a problem in the agency,
wealth of its shareholders by balancing the costs with a possibility that the controlling
and marginal benefits using the right allocation shareholders (insiders) are exploiting its
strategy (Opler et al., 1999). However, the company resources.
problem associated with the use of this This research aims to determine the
technique is determining the cash holding implications of excess cash holdings to the value
excessiveness. This research, therefore, focuses of a company using the agency theory
on the real difference of the cash holding, with a empirically. It also defines the moderating
strategic benefit for company values as opposed variable of concentrated and dispersed
to the old viewpoint, which is only considered as ownership to strengthen the negative values of
part of the working capital. According to Powell the company. Earlier methodologies were based
and Baker (2010), a company's decision on the on Fama and French (1998). However, this
amount of money to be held can affect its value. research applied the modern specification model
Companies tend to allow flexibility to avoid based on the creation of value by Ramezani et
poor investment and financial difficulties. Cash al. (2002) and Bacidore et al. (1997).
holdings are accumulated to anticipate future
investment opportunity with higher values LITERATURE REVIEW AND
(Mikkelson & Partch (2003), Simutin (2012), HYPOTHESES DEVELOPMENT
and Faulkender & Wang (2006)) According to According to Jensen and Meckling (1976),
Livdan et al. (2009), the effects of financial agency theory arises due to the presence of
constraints on risk, showed that excess cash information asymmetry and conflict of interests.
holdings contain information used to reduce Excess cash holdings are the backup money
financial constraints. Therefore, investors allocated to a company for its daily operation
respond more positively. Conversley, Fresard, (Attig et al. 2011). It is also defined as the most
and Salva (2010) stated that excess cash holdings favored and cheapest kind of liquid asset
are monies that are not tied to operation and converted into another asset. A company needs
investment but inefficiently squandered and to allocate cash holdings at a reasonable price, to
misused. Excess cash holdings are company avoid paying off excesses to shareholders.
resources that are not aligned with the interests According to Faulkender and Wang
of its shareholders (Jensen (1986); & Stulz (2006), the marginal cash value of nonfinancial
(1990)). This argument is in line with Simutin's companies in the United States from 1971-2001
(2010) and Khieu & Phyles (2012) opinion, decreased with an increase in cash holdings.
which stated that the agency problem tends to Similarly, in 2012, Chen et al. researched 8016
exist due to excess cash holdings. companies in the United States and found that
Lower values are obtained with the the addition of cash to an already abundant
exploitation of a company’s resources by amount led to agency problems. Pinkowitz and
managerial shareholders. The lower value is in Williamson (2004) stated that the presence of
line with the research conducted by Faulkender agency problems was due to the misuse of funds
and Wang (2006), Lee and Powell (2011), Chen, by the managers, thereby leaving debtors to
et al. (2012), which stated that the marginal enjoy the profit from the company liquidation.
value of cash holdings decreases following the The description led to the following hypothesis:
increase in the company’s income. According to H1: excess cash holdings negatively affect the
Pinkowitz and Williamson (2004), a unit of Value of a company.
currency significantly contributes to the return of
This study emphasizes the availability
less money, when the company's shareholders
of empirical evidence in dealing with the

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problems associated due to excess cash holdings. incentives to supervise management due to the
According to the entrenchment theory, agency expensive rate of the monitoring fee. Also, when
conflict type 2 has a higher chance of occurring the performance of a company increases, the
in companies with a significant number of benefits are reaped by all investors.
influential shareholders. These categories of However, the lack of managerial
people are capable of using their rights to re- supervision by shareholders leads to personal
distribute wealth among themselves. According incentives by using company funds to carry out
to previous research, reduction in company luxurious personal activities. Jensen (1986)
performance tends to occur due to the high stated that managers might accumulate cash
distribution of shares among insiders (Mitton, holdings for their benefits, which tend to reduce
(2002), Lemons & Lins (2003), Suranta & the risk of companies from going extinct.
Midiastuty (2003), and Gunarsih (2003)). Therefore, the following hypothesis is proposed:
Companies in many countries, H3: the negative effects of excess cash holdings
including Indonesia, consist of a concentrated toward the value of the company are strong-
ownership structure with inner shareholders in er when the ownership is widely dispersed.
dominant positions capable of controlling Jensen and Meckling (1976) proposed
managers (La Porta et al., 1999). The an agency conflict between shareholders and
shareholders can expropriate minority debtors. According to their research, some
shareholders and creditors (Shleifer & Vishny shareholders need excess cash holdings to be
(1986), Stulz (1988), and Burkart et al. (1997)). invested in high-return programs, which are
According to Faisal (2013), the concentration risky. However, the shareholders believe that
level of insiders following empirical testing is when a company has serious financial
above 70%. Therefore, the second hypothesis is difficulties, the benefits associated with excess
as follows: cash holding are allocated to the debt holders. A
H2: the negative effects of excess cash holdings company’s value tends to raise with benefit to
on the value of the company are stronger
when the ownership is concentrated. the cash holdings of the shareholders and vice
versa (Pinkowitz and Williamson, 2004). The
Conflicts in agencies tend to arise from proposed hypothesis is as follows:
the separation of ownership and control, which H4: the negative effects of excess cash holdings
occurs in companies with smaller investors toward the value of the company are strong-
(Jensen & Meckling (1976), and Morck et al. er when it faces financial difficulties.
(1988)). According to a research conducted by The following is a framework of conceptual
Jani et al. (2004) using ownership of shares less research:
than 30%, shareholders have low or none

Figure 1. Research Framework: The Negative Effects of Excess Cash Holdings on Value of the Firm

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METHODS gression model and the goodness of fit, which

are the values of Adjusted R2, and SSR (Sum
Methods To Estimate Normal Cash Holdings squared Residual). The higher the value of Ad-
justed R2, and less the SSR, the better the model.
Excess cash holdings are determined by
According to those criteria, the excess
the residual value of estimated cash holdings.
cash holdings are calculated based on two of the
This research, therefore, uses three approaches
best specification as follows:
with a data panel structure to estimate the value
=
of cash holdings.
0,091+0,003GROWTH+0,008SIZE_RIIL-
0,006DDISTRESS+2,45RV-0,011CFV
a. Static panel data regressive model. The mod-
+0,036CFLOW-0,01CAPEX-0,056CONVERT-
el implicitly estimates the value of the cash hold-
0,057DDIV_DPS +0CCC+0,007DEBTMAT-
ings of the static models, with the assumption
0,18TANGIBLE+0,441AR(1)
that there is no need to adjust the new cash hold-
ings target. The model is as follows:
0,031-0,002GROWTH+0,01SIZE_RIIL-
∑
0,013DDISTRESS+2,235RV-
(1)
0,001CFV+0,016CFLOW-0,085CAPEX-
0,034CONVERT-0.031LEV
b. Dynamic panel data regression model. This +0,007DDIV_DPS+0CCC+0,006DEBTMAT-
model admits that there is an adjustment process 0,151TANGIBLE +0,243CASHHOLDING(-1)
to standard cash holdings, thereby leading to a
lag. Methods To Test Research Hypothesis
The autoregressive dynamic regressive statistic
The research sample is selected from com-
model is as follows:
panies with positive excess cash holdings and
complete data, which are determined by the val-
∑ (2)
ue of residual estimation from the chosen specifi-
cation model. A total number of 672 observa-
c. The regressive model with the method esti- tions were obtained from consumer discretionary
mated GLS through the procedure iterative (185), Materials (143), staples (110), and indus-
Cochrane Orcutt. Autocorrelation is showed by tries (104).
the interdependency of disruption from one re-
gressive model following the AR (1) structure. Research Variables in terms of definition, formu-
The model is an estimator GLS method with the la, and identification used to test the hypothesis
regressive statistic model of EGLS as follows: are provided in the table below.
The agency problem tends to exist due to excess
∑ (3) cash holdings.

Explanation : The Research Statistics Model of this research

= is Yi,t = α0 + β1Xi,t + Ʃβ2CONTROLS it + ε i.
CASH HOLDINGSt– ρCASHHOLDINGSt-1 Coefficient β is estimated by using the
̅ = Xi,t– ρXi,t-1 Moderated Regression Analysis approach, as
̅t = ut– ρut-1 seen in Table 2.

Symbol αi and αt are firm-specific effects and

RESULT AND DISCUSSION
period-effects. X is a vector containing independ-
ent variables, known as an investment oppor-
tunity (GROWTH), company size The research hypothesis is tested using
(SIZE_RIIL), financial difficulties (DISTRESS), two models. The first calculates the value of the
cash flow volatility (RV) or (VCF), cash excess cash holdings using the residual value by
flow(CFLOW), investment (CAPEX), converti- estimating the static model regression.
bility (CONVERT), leverage (LEV), dividend
The second calculates it using the residual
(DDIV_DPS), cash conversion cycle (CCC),
debt maturity (MATURITY), assets tangibility value of estimated model dynamic regression.
(TANGIBLE). The cash holdings estimators are The estimated result of each hypothesis is as
selected based on the criteria of the BLUE re- follows:

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Table 1. Variable Definitions to Test Research Hypothesis

Variable
Variable Definitions and Formulas
Identification
ABNRETURNi,t Abnormal return is a proxy of the value of the firm, with Dependent
excesses from the normal return as follows: Variable

i.tis abnormal return

R i,t is the individual return

( )Expected return, using market return. Formula:

XCASH Excess Cash Holdings is calculated from the residual value with Independent
HOLDINGSi,t a positive sign as Variables
follows:

DOWN1 is dummy variable, DOWN1 set one if the most significant Moderating
shareholders have some share 70% <share <100%, and Variables
DOWN1 set zero, otherwise
DOWN2 is dummy variable, DOWN2 set one if the most significant
shareholder has share <25%, and DOWN2 set zero, otherwise.
DISTRESS is the dummy variable, which measured by the TIER ratio.
Formula TIER = . Dummy variable set one if
TIER<0, and zero otherwise
EVA i,t Economic Value Added is a financial performance measure based Controlling
on the shareholder's value creation. Formula: Variables
⁄
NOPAT = Net Operating Profit After Tax
CAPITAL = Book Value of Equity
WACC= Weighted Average Cost of Capital, from Database
Bloomberg
RISK i,t is the deviation of asset pricing as a proxy of unsystematic risk
normalized by asset total t
SIZEi,t is company size
Formula:

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Table 2. Statistics Test Model and Sign Prediction

Hypothesis Sign Regression Equation
Prediction
H1 β1 negative ABNRETURN t,i = α1 + β1XCASHHHOLDINGSi,t + Ʃβ2CONTROLS it +ε
it

H2 β3 negative ABNRETURNt,i = α1 + β1XCASHHHOLDINGS i,t + β2DOWN1i,t + β3

i,t * DOWN1,t +Ʃ β4CONTROLS it +ε it
H3 β3 negative ABNRETURNt,i = α1 + β1XCASHHHOLDINGSi,t+ β2DOWN2i,t +
β3XCASHHOLDINGSi,t * DOWN2i,,t + ƩβiCONTROLSit +ε it
H4 β3 negative ABNRETURNt,i = α1 + β1XCASHHHOLDINGSi,t+ β2DISTRESSi,t +
β3XCASHHOLDINGSi,t *DISTRESS,t + ƩβiCONTROLSit +εit

Table 3. The Effect of Excess Cash Holding on Firm Value

Dependent Variable: ABNRETURN
1 2
Coef. t-Stat Coef. t-Stat
C -0,209-1,340 -0,441-5,769***
XCASHHOLDING -0,767-2,730***-0,579-2,588***
EVA 1,74419,533*** 1,69926,425***
RISK 1,146 3,401*** 0,953 4,651***
SIZE -0,006-0,710 0,015 2,372**

Observation 672 773

Table 4. The Role of Concentrated Ownership in Strengthening the Negative Effect of Excess Cash
Holding on Value of the Firm
Dependent Variable: ABNRETURN
1 2
Concentrated Share Ownership
Coef. t-Stat Coef. t-Stat
-
- 7,23
C -0,473 -3,326 *** 0,442 7 ***
-
- 1,38
XCASHHOLDING -0,184 -0,680 0,311 1
32,5
EVA 1,706 40,285 *** 1,739 02 ***
5,54
RISK 1,118 3,785 *** 0,899 6 ***
2,13
SIZE 0,011 1,066 0,015 9 **
-
- 2,14
DOWN1 0,058 1,237 0,103 6 **
-
- 1,76
XCASHHOLDING*DOWN1 -4,433 -4,012 *** 2,321 9 *
Observation 644 734

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Table 5. The Role of Widely Spread Ownership in Strengthening the Negative Effect of Excess Cash
Holding on Value of the firm
Dependent Variable: ABNRETURN
1 2
Widely Spread Share Ownership
Coef. t-Stat Coef. t-Stat
C -0,463 -2,485 ** -0,466 -5,312 ***
XCASHHOLDING -0,507 -3,926 *** -0,050 -0,127
EVA 1,657 32,845 *** 1,641 44,739 ***
RISK 1,059 3,249 *** 0,858 4,528 ***
SIZE 0,012 0,923 0,016 2,196 **
DOWN2 0,032 0,673 -0,007 -0,208
XCASHHOLDING*DOWN2 -2,537 -2,492 ** -2,385 -2,644 ***

Observation 644 734

1.

Table 6. The Role of Financial Difficulties in Strengthening the Negative Effect of Excess Cash
Holding on Value of the firm
Dependent Variable: ABNRETURN
1 2
Financial Difficulties
Coef. t-Stat Coef. t-Stat
C -0,326 -0,326 * -0,462 -0,462 ***
XCASHHOLDING 0,451 0,451 -0,346 -0,346
EVA 2,050 2,050 *** 1,504 1,504 ***
RISK 1,256 1,256 *** 1,199 1,199 ***
SIZE -0,001 -0,001 0,014 0,014
DISTRESS -0,174 -0,174 ** -0,154 -0,154 ***
XCASHHOLDING*DISTRESS -2,853 -2,853 * -4,794 -4,794 ***

Observation 591 649

2. The summary of the estimation is shown in Table 7.

Table 7. Summary of Estimated Result

Hyp Model β Direction Coeff. t-Stat Decision

H1 1 β1 negative -0,767 -2,730 *** H1

2 β1 negative -0,579 -2,588 *** Support and robust
H2 1 β3 negative -4,433 -4,012 *** H3
2 β3 negative -2,321 -1,769 * Support and robust

H3 1 β3 negative -2,537 -2,492 ** H4

2 β3 negative -2,385 -2,644 *** Support and robust
H4 1 β3 negative -2,853 -1,588 * H5
2 β3 negative -4,794 -8,526 *** Support and robust

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Result of The Effect Of Excess Cash Holdings the free-rider problem. According to Faisal (2013),
Toward The Company Value a company's value decreases when the
Hypothesis 1 estimates that excess cash concentration level of ownership is lower than 30%
holdings negatively affect a company’s coefficient due to the problem associated with the free-rider.
value. Therefore, hypothesis 1, which stated that
excess cash holdings affect a company’s value The Result Of The Effect Of Financial
negatively, is supported. This empirical finding Difficulties In Moderating The Effect Of Excess
showed that excess cash holdings are a significant Cash Holdings Toward The Value Of A Company
pointer to supporting the agency hypothesis. Financial difficulty is a problem caused by
Therefore, this research supports the agency cost of the inability of a company to fulfill its obligation.
free cash flow theories of Pinkowitz & Williamson When a company faces financial difficulties, it
(2004), Faulkender & Wang (2006), Lee & Powell means that the chosen investments are those with
(2011), and Chen et al. (2012). very low risk; therefore, shareholders do not have a
choice in placing it in other projects with higher
The Result Of The Effect Of Concentrated returns, to avoid agency conflict. The result of
Ownership In Moderating The Effect Of Excess estimation and re-estimation shows that the
Cash Holdings Toward The Value Of A Company coefficient interaction consists of negative signs and
Hypothesis 3 estimates the effect of significance. Therefore hypothesis 5 is supported in
concentrated ownership in strengthening the that a company with severe financial difficulties.
negative effects of excess cash holdings toward the This research result is consistent with the findings
value of a company. The result shows that the of Pinkowitz and Williamson (2004), which stated
negative effects of excess cash holdings toward the that cash holdings are valued less when the
value of a company are stronger when the main company has financial difficulties and responded
shareholder is over 70%, as shown on model 2, negatively by outside investors because they prefer
with a similar significant sign of the coefficient. investments with higher returns.
Therefore, the hypothesis is supported. The
highly concentrated ownership affects the negative CONCLUSIONS
effects of excess cash holdings because over 70% of
the proportion, are dominant (Jani et al. (2004), In conclusion, the findings prove that excess
and Faisal (2013)). The expectations in the cash holdings negatively affect the value of a
occurrence of agency problems are reflected in the company, therefore, it is a significant clue in
cutting of company value by outside investors. This supporting the agency hypothesis. The highly
test result supports the findings of Liu (2011) and concentrated ownership structure is supported by
Attig, et al. (2011), Kusnadi (2011). the research data, that strengthens the negative
effects of excess cash holdings toward the
Result From The Effect Of Highly Dispersed company's value. This is consistent with the
Ownership In Moderating The Effect Of Excess expropriation/entrenchment hypothesis, which
Cash Holdings On Firm Value stated that the expropriation act is more dominant
Hypothesis 4 estimates the effect highly when the company ownership is highly
dispersed ownership strengthens the negative effects concentrated. The result is consistent with the
of excess cash holdings toward the value of a managerial entrenchment hypothesis, which stated
company. The testing result shows a negative sign that the act of expropriating excess cash holdings by
on the coefficient of interaction, which is supported management is more dominantly conducted when
by the result of the second model. Therefore the there is a free-rider problem amongst the
problem of agency between shareholders and the shareholders due to dispersed ownership, thereby,
supported manager is in line with the findings of leading to inadequate management supervision.
Kalcheva and Lins (2007), Lee and Lee (2009), and Besides, the agency problem between the insider
Faisal (2013). Highly dispersed ownership allows and the debt holders when the company has severe
the entrenchment of company management due to financial difficulties leads to low-risk investment.

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 Ernie Hendrawaty / International Business and Accounting Research Journal 4 (2) (2020)

The result elicits negative responses from outside Finance and Takeovers. American Economic
investors. Therefore, the hypothesis is supported. Review76(2).
Kalcheva, I. dan K. V. Lins (2007)."International
evidence on cash holdings and expected man-
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