CASH HOARDS AND CHANGES IN INVESTORS' OUTLOOK

Authors


  • We are grateful to Sattar Mansi (associate editor) and Jesus Salas (referee) for valuable suggestions that greatly improved the paper. We also thank seminar participants at the University of Lethbridge, University of Saskatchewan, and the 2009 participants at the Financial Management Association meetings for very constructive and helpful comments. Ebenezer gratefully acknowledge the financial support from the University of Lethbridge Research Fund #13136 and the Faculty of Management Seed Fund. Any mistakes are ours alone.

Abstract

Declining markets reflect declines in investors' outlook for firm prospects, increasing their expectation that firms will waste excess cash. In contrast, excess cash is useful in mitigating financial distress associated with poor earnings. We find an inverted U-shaped relation between stock return and excess cash in declining markets, suggesting the positive effect of excess cash dominates at low levels of cash, while the negative effect dominates at high levels. We also document an inverted U-shaped relation for firms with weak shareholder power and firms with high information asymmetry in advancing markets. These suggest investors' desire for cash reserves is limited.

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