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To have cash is good but not as good as you may think

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Staff writer ▼ | October 2, 2015
Cash reserves
Study   Huge cash reserves may have significant implications

Companies tend to have as much cash on hand as possible because it allows them to react quickly and spend at will. However, the value of most businesses is secured within things that generate income, such as buildings, machines and wages.

Some cash is retained for cash flow, as companies need enough cash to move value through their business smoothly and on time – from sales to contractors and to staff.

Companies do, however, build up significant cash reserves, the reasons and implications of which fascinate Assistant Professor Yuanto Kusnadi of the Singapore Management University (SMU) School of Accountancy.

He studies corporate financial policy, which is how a firm chooses to fund its investments and operations, for example through debt, raising capital or by drawing from cash holdings.

"While cash is the most liquid asset on the balance sheet, it is also the most easily expropriated by corporate insiders. It also generates relatively low returns," says Professor Kusnadi, whose research has identified ways for investors to assess the risks associated with investing in cash-rich companies.

Professor Kusnadi began his research into cash-rich companies after being intrigued by anecdotal evidence that, despite the drawbacks and dangers of having large cash reserves, US firms appeared to have increased their cash holdings over the past two or three decades, and these included giant firms such as Microsoft and General Motors.

Earlier studies, which focused on the US market, had only managed to identify financial constraints as a factor in the decision made by businesses to hold on to cash. Professor Kusnadi went beyond this with a broader study of global factors, looking at international firms operating in 39 countries.

The resulting paper, published in 2011, identified new factors behind companies' decisions to hold on to their cash.

"The main finding revealed that firms in countries with strong investor protection, such as Singapore, were less likely to funnel cash out of cash flows into cash holdings to fund investments," Professor Kusnadi says. Instead, these firms used the capital market or debt to fund investments.

The study found that the firms holding more cash were those with less effective corporate governance attributes, such as firms controlled by families or with pyramidal ownership structures, and those with a single person acting as CEO and chairman. Across the board, these firms had little incentive to distribute any excess cash to minority shareholders.

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