1

Additional international evidence on

corporate cash holdings
Yilmaz Guney
University of Surrey, UK
Aydin Ozkan
*
University of York, UK
Neslihan Ozkan
University of Liverpool, UK
Abstract
This paper investigates corporate cash holding behaviour in Japan, France, Germany, and the
UK using data for 3,989 companies over the period 1983-2000. Our findings reveal that a
countrys legal structure and ownership structure of firms play a significant role in determining
cash holdings. We observe that higher degree of shareholder (creditor) protection is associated
with lower (higher) cash holdings and ownership concentration exerts a negative impact on cash
levels. Moreover, the dynamic cash holding analysis indicates that firms tend to adjust their
cash levels towards a target cash structure. The speed of adjustment of cash holdings for
France, Germany and Japan is found to be similar while firms in the UK seem to adjust to the
target cash level more quickly.
JEL classification: G3; G32
Keywords: Cash holdings; legal characteristics; ownership structure; endogeneity.

*
Corresponding author. Department of Economics and Related Studies, University of York, Heslington,
York, YO10 5DD, UK. Tel.: + 44 (1904) 434672. Fax: + 44 (1904) 433759. E-mail: ao5@york.ac.uk.
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1. Introduction
The decision of firms to hold substantial cash reserves has recently been a focus of
attention in finance literature (see, for example, Opler et al., 1999; Dittmar et al., 2002;
and Ozkan and Ozkan, 2002). It is argued that the main benefit of holding cash in an
imperfect capital market is the increase in firms ability to avoid excessive costs of
external financing. However, it is also recognised that there are costs associated with
holding cash. The most obvious of these costs is that managers and controlling
shareholders can retain cash to pursue their own private objectives, which need not
coincide with those of outside investors (Jensen, 1986).
Empirical investigation of the cash holding decision has so far focused mainly on the
role of firm-specific factors in the determination of cash levels of firms. One important
contribution in this respect is provided in Opler et al. (1999) who examine the
determinants of cash holdings for publicly traded U.S. firms. They observe that larger
firms tend to hold lower cash reserves. They also report that firms with stronger growth
opportunities and riskier cash flows hold relatively high level cash. Again, for a sample
of U.S. firms, Kim et al. (1998) provide similar findings. Furthermore, Pinkowitz and
Williamson (2001) investigate the effect of bank power on cash holdings using firm
level data for the US, Germany, and Japan. Their results demonstrate that cash levels of
Japanese firms are affected by the monopoly power of banks.
More recently, there has been more emphasis on the role of corporate governance in
explaining the corporate cash holding behaviour. In a recent study, Ozkan and Ozkan
(2002) analyse the impact of ownership structure of firms on their cash levels using a
sample of UK firms. They provide evidence of a non-monotonic relationship between
managerial ownership and cash holdings. They observe that cash holdings are
negatively impacted by managerial ownership at low levels of ownership but the impact
is reversed at higher levels. They also find that firms with ultimate controllers hold
higher levels of cash than widely held firms. Their findings with respect to other firm-
specific factors are mainly in line with the prior evidence for U.S. firms. Dittmar et al.
(2002) analyse the relationship between corporate governance and cash holdings by
focusing on the impact of shareholder protection by using cross-sectional firm-level
data from 45 countries. Their main finding is that firms that operate in countries where
shareholder protection is poor tend to hold higher levels of cash. They argue that their
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results provide evidence that agency problems, proxied with shareholder rights across
countries, are of primary importance in determining cash holdings of firms.
One reason why the relation between corporate governance and cash holdings has
gained increasing attention is that recent research has provided strong support for the
importance of legal and institutional characteristics in understanding the patterns of
corporate finance in different countries (see, for example, La Porta et al. 1997, 1998).
The main finding of this strand of literature is that protection of shareholders and
creditors by the legal system can influence the agency costs. This is mainly because of
the potential expropriation of minority shareholders and creditors by managers and
controlling shareholders.
To the extent that these costly agency relations affect the cost of external financing
one should expect to observe different levels of cash held by firms across countries that
provide investors with different levels of protection. For example, if a country has a
legal structure with a strong protection of investors, expected agency costs between
outsiders and insiders will be lower and external finance will be relatively easier to
attain. In this setting, firms will have less incentive to accumulate large amounts of
cash. This is consistent with Dittmar et al. (2002) who focus on shareholder protection
and find a negative relation between shareholder protection and cash holdings.
In this paper, we provide additional international empirical evidence on the
importance of corporate governance issues for cash holdings. We argue that there are
other important aspects of corporate governance, which are likely to exert influence on
cash holding decisions of firms. To investigate this, in addition to shareholder
protection, we incorporate more legal and institutional characteristics such as rule of
law index, ownership concentration, degree of creditor protection for a large sample of
firms from Japan, France, Germany, and UK.
We argue that strong rule of law and creditor protection increase the probability of
bankruptcy in financial distress, which would in turn imply more accumulation of cash
as a precaution to avoid financial distress. Our empirical analysis provides strong
support for this prediction. There is evidence that suggests that firms tend to hold large
cash balances in countries with better creditor protection and higher quality of law
enforcement.
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In addition, ownership structure of firms in a country may be important in
determining cash reserves that firms choose to hold. It is possible that ownership
concentration can lead to a reduction in agency costs of external finance since large
shareholders have more incentives to monitor the management effectively. To the
extent that this leads to a reduction in the cost of external finance, firms would be
expected to hold less cash in countries with higher ownership concentration. However,
an alternative hypothesis might be that large shareholders could have incentives to
accumulate cash to maximise funds under their control and avoid external markets
discipline. Consistent with the former view, we find a negative relation between
ownership concentration and cash balances of firms.
Our second contribution lies in the panel data analysis of cash holdings. Panel data
techniques have been used in recent research to mainly control for unobserved firm
heterogeneity (see, for example, Opler et al., 1999; and Pinkowitz and Williamson,
2001). In this paper, we adopt a dynamic cash model and estimate it using Generalised
Method of Moments (GMM) estimation method. There are essentially two advantages
of this approach. First, it is more effective in controlling for the potential endogeneity
problem than fixed-effect (within) estimation method that has been widely used in prior
research. Although fixed effects estimation method controls for time-invariant
unobserved firm-specific factors, it does not take into consideration the potential
endogeneity problem. We believe that the endogeneity problem might arise in this
context for several reasons. For example, random shocks influencing firms cash
holding decisions can also influence other firm-specific factors, such as firms leverage
and growth opportunities. Furthermore, the observed empirical relationships between
firms cash holdings and firm-specific variables might reflect the impact of cash
holdings on the latter rather than vice versa. We observe that estimated results vary
significantly with respect to some of the variables after controlling for endogeneity.
This, we argue, suggests that endogeneity problem should be addressed to avoid biased
conclusions about the determinants cash holdings of firms.
The second advantage of our approach is its ability to address the dynamic nature of
cash holding behaviour of firms. We utilise a partial target-adjustment model to
investigate whether firms in different countries have target cash holdings and, if they
do, how they differ in their speed of adjustment to the target cash level. This approach
5
allows for the possibility of delays in response of firms in adjusting their cash holdings.
We argue that market imperfections such as adjustment costs may prevent firms from
adapting to new circumstances leading to such delays.
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We find that firms in all
countries in our sample have target cash holdings and adjustment speed of cash holdings
towards the target is quite similar for German, French, and Japanese firms whereas UK
firms seem to adjust their cash holdings at a relatively higher speed.
The remainder of the paper is organised as follows. In section 2, we discuss
institutional and legal characteristics that are relevant for cash holdings. In section 3,
we review the firm-specific characteristics that are expected to have a significant role in
determining firms cash holding decisions. Section 4 discusses the empirical methods
and describes the data. Section 5 presents the results and Section 6 concludes.
2. Country-specific characteristics that influence cash holding decision
This section contains a discussion of the role of country-specific factors, such as
shareholder protection, creditor protection, quality of law enforcement and ownership
structure, in affecting cash holding incentives of firms.
Legal environment and cash holdings
Conflicts of interests between corporate insiders, namely managers and controlling
shareholders, and outside investors can create agency costs, which would in turn
increase the cost of external financing. One such example is the agency problem of free
cash flow in excess of the amount required to fund all valuable investment projects.
Jensen (1986) argues that free cash flow presents serious potential conflicts because
large amount of cash reserves can serve mainly managers interests. Managers have
incentives to increase the amount of funds under their control because this enables them
to spend it as they wish, i.e. squandering funds by consuming perquisites and/or making
inefficient investment decisions. On the other hand, shareholders may prefer that free
cash flow be returned to them.

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We are not the first to investigate the question whether firms have target cash holdings. Opler et al.
(1999), for example, also provide evidence that firms have target cash levels. Differently from their
analysis, however, our model incorporates all the firm-specific factors described in the paper as relevant
in determining cash holdings. More importantly, in estimating the target-adjustment model, we also
control for unobservable fixed effects as well as time effects. To the extent that these effects are
significant in the underlying target cash model and not controlled for, estimated coefficients of the target-
adjustment model will be biased.
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What role does the legal environment play in reducing the costs associated with
conflicting interests of insiders and outside investors? It is argued that the severity of
agency costs vary with the degree of protection the outside investors receive, which has
implications for the ability of firms to raise external debt and equity finance (La Porta et
al. 1997, 1998). For example, in a country where the protection of outside investors is
poor, expected agency costs will be higher and firms access to external finance funds
will be limited. In such an environment, firms are more likely to accumulate cash. In
this paper, we distinguish between shareholder and creditor protection. As also
discussed in Dittmar et al. (2002), it is more likely that firms will hold less cash in
countries with strong shareholder protection. This is due to lower expected costs
associated with the agency problem described above and hence the lower cost of
external equity. However, we argue that the impact of creditor protection on cash
holdings can be different from that of shareholder protection. Strong creditor protection
can increase the likelihood of bankruptcy when firms experience financial distress. We
predict that this makes managers more conservative in relation to the levels of cash they
hold. As a result, they accumulate more cash in an attempt to reduce the threat by
strong creditors of bankruptcy in financial distress.
In this paper, we investigate the impact of legal characteristics on incentives of firms
to hold cash by considering several indicators developed by La Porta et al. (1997).
First, we use a measure for quality of law enforcement, rule of law, which is an
assessment by investors in different countries of the law and order environment they
operate in. Second, as a proxy for shareholder rights we employ their measure of Anti-
director rights index. This index aggregates such elements of shareholder rights as the
ability to vote by mail, the possibility of cumulative voting for directors, the ease of
calling an extra ordinary shareholder meeting, and the availability of legal mechanisms
of protecting minority shareholders from expropriation by directors. Finally, as a
proxy for creditor rights, creditor rights index is used. This aggregates the various
rights that secured creditors might have in liquidation and reorganisation. Restrictions
on the managers ability to seek unilateral protection from creditors, mandatory
dismissal of management in reorganisation, lack of automatic stay on assets, and
absolute priority for secured creditors all contribute to the calculation of this index.
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[INSERT TABLE 1 HERE]
Table 1 presents the values of these indicators for France, Germany, UK and Japan.
Creditor rights are strongest in the UK and weakest in France. Out of 4 the scores of
Japan and Germany are 2 and 3 respectively. UK also has the strongest anti-director
rights, while Germany has the weakest one. France and Japan score 2 and 3 out of 5,
respectively.
Ownership, control and cash holdings
A major institutional difference among the countries in our sample is due to
ownership concentration. As can be observed from Table 1, the ownership of firms in
the UK and Japan is largely dispersed, while it is highly concentrated in France and
Germany. The ownership concentration is 13 percent and 15 percent for Japan and UK,
while it is 24 percent and 50 percent for France and Germany, respectively.
2
Ownership concentration might have important implications for potential agency
problems. However, the effect of ownership concentration on cash holding behavior is
not unambiguous. It is argued that one of the ways of controlling the agency problem
between managers and shareholders is to effectively monitor managers to ensure that
they act in the interests of shareholders. However, for an average shareholder there may
not be enough incentives to monitor managers as the cost of monitoring is likely to
outweigh the benefit (Grossman and Hart, 1988). In contrast, large shareholders,
having claims on a large fraction of the firms cash flows, can monitor managers more
effectively and free riding problems involved in monitoring are mitigated.
Consequently, in the presence of a large shareholder, managerial discretion is curbed to
some extent and agency costs between management and shareholders are reduced
(Stiglitz, 1985; Shleifer and Vishny, 1986). If this is the case, the cost of external
financing would be lower for firms with large shareholders, that is, with high ownership
concentration. This in turn implies less need to hold larger levels of cash.

2
There is also evidence that there are substantial differences in the nature of ownership across the
countries in our sample (see, for example, Claessens et al, 2000 for Japan and Faccio and Lang, 2002 for
others). In the UK nearly 64 percent of non-financial firms and in Japan 79.8 percent of all firms are
widely held at the 20 percent threshold. However, in France and Germany percentage of firms that are
widely held is relatively much lower, respectively 12 and 10 percent.
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On the other hand, there are also private benefits of control accrued to large
shareholders, not necessarily shared by minority shareholders. Large shareholders
might have incentives to increase the amount of funds under their control to consume
corporate benefits at the expense of minority shareholders. One way of doing it is
obviously to accumulate large amounts of cash. With higher levels of cash holdings it is
less likely that controlling shareholders will relinquish control and share the efficiency
gains with outside shareholders. These arguments suggest a positive relationship
between ownership concentration and cash balances.
3. Firm-specific characteristics that influence cash holding decision
In this section, we provide a brief review of the firm-specific characteristics
identified by theory as relevant in determining firms cash holding policies.
Growth opportunities
It is predicted that there is a positive relation between cash reserves and growth
opportunities of firms. This prediction is mainly based on the view that external
financing is more costly for firms with greater growth opportunities. There are at least
two explanations as to why this might be the case. First, growth firms face higher
agency costs because, when the investment opportunity set of firms consists of growth
opportunities, firms with risky debt pass up some of the valuable investment
opportunities in some states of nature (Myers, 1977). Second, a high degree of
information asymmetry can make external financing expensive. Myers and Majluf
(1984) argue that asymmetric information is more severe between insiders and outside
investors for firms whose values are largely determined by growth options.
Consequently, firms hold accumulate more cash to avoid costly external financing and
hence the possibility that they will have to give up valuable investment opportunities.
It can also be argued that firms with greater growth opportunities are expected to
incur higher bankruptcy costs (see, for example, Williamson, 1988; and Harris and
Raviv, 1990; Shleifer and Vishny, 1992). Growth opportunities add value to a firm but
they cannot be collateralized and do not generate current income. They are intangible in
nature and their value will fall precipitously in financial distress and bankruptcy. Larger
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expected costs would in turn imply that firms with greater growth opportunities have
larger cash holdings to avoid financial distress and bankruptcy.
As a proxy for growth opportunities of firms we use the market-to-book ratio
(MKTBOOK) defined as the ratio of book value of total assets minus the book value of
equity plus the market value of equity to book value of assets.
Cash flow and cash flow variability
The influence cash flow exerts on cash holdings of firms is not clear-cut. It is argued
that in the presence of asymmetric information and signalling problems associated with
external funding, firms have a preference for internal over external finance (Myers and
Majluf, 1984). This implies a positive influence of cash flow. Also, to the extent that
cash flows are a proxy for growth options the relationship between cash flow and cash
holdings should be positive. On the other hand, it is worth noting that cash flow might
exert a negative impact on cash holdings. Kim et al. (1998) argue that cash flow
provides a ready source of liquidity for investment and maturing liabilities.
Furthermore, the risk of having to pass up valuable investment opportunities and facing
financial distress is lower for firms with higher cash flows. Accordingly, such firms can
afford to have lower cash holdings. We measure cash flows (CFLOW) as the ratio of
pretax profit plus depreciation to total assets.
The greater the firms cash flow variability, the greater the number of states of nature
in which the firm will be short of liquid assets. As mentioned earlier, it may be costly
to be short of cash and marketable securities if the firm has to pass up valuable
investment opportunities. There is evidence that firms with cash shortfalls do indeed
fail to take up some of the valuable growth opportunities. For example, Minton and
Schrand (1999) show that firms with higher cash flow volatility permanently forgo
investment rather than reacting to cash flow shortfalls by changing the discretionary
investment timing. Thus, firms with more volatile cash flows are expected to hold more
cash in an attempt to mitigate the expected costs of liquidity constraints. The measure
we use for cash flow variability (VARIABILITY) is the standard deviation of the first
difference in cash flows scaled by the average book value of total assets for 10 years
prior to the current year (at least 6 years if data are missing).
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Leverage and maturity structure of debt
To the extent that leverage ratio acts as a proxy for the ability of firms to issue debt
one would expect a negative relation between leverage and cash holdings. According to
this view, firms can use borrowing as a substitute for holding high levels of cash and
marketable securities (John, 1993). Moreover, Baskin (1987) argues that the cost of
funds used to invest in liquidity increases as debt financing increases, implying a
reduction in cash holdings with increased debt in capital structure. However, it should
be noted that higher debt levels can increase the likelihood of financial distress. In that
case one would expect a firm with a high debt ratio to increase its cash holdings to
decrease the likelihood of a financial distress. This would induce a positive relation
between leverage and cash holdings. Leverage (LEV) is measured by the ratio of total
debt (both short-term and long-term) to total assets.
Debt maturity structure can also be important in determining the amount of cash and
marketable securities firms wish to hold. One key insight from theoretical debt maturity
models is that firms with a high degree of potential informational asymmetry are likely
to issue short-term debt (see, e.g., Myers, 1977; Flannery, 1986; Kale and Noe, 1990;
Diamond, 1993). To the extent that short-term debt is a proxy for the high degree of
informational asymmetry, firms with more short-term debt in their capital structure are
expected to hold more cash. This is because their access to other external financing
would be limited by the high degree of informational asymmetry. Also, given the risk
associated with the rolling over of short-term debt more frequently, firms may want to
hold greater amounts of cash and marketable securities. We define the debt maturity
structure (LDEBT) as the ratio of debt that matures in more than one year to total debt.
Size
It is argued that larger firms are more likely to be diversified and thus less likely to
experience financial distress (Titman and Wessels, 1988). Ozkan (1996) suggests that
smaller firms are more likely to be liquidated when they are in financial distress. Also,
smaller firms face more borrowing constraints and higher costs of external financing
than larger firms (Whited, 1992; Fazzari and Petersen, 1993, and Kim et al., 1998). The
above argument suggests a negative relationship between size and cash holdings of
firms. Furthermore, it is argued that larger firms have less information asymmetry than
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small firms do (see, e.g., Brennan and Hughes, 1991; and Collins et al., 1981). To the
extent that size is an inverse proxy for the degree of informational asymmetry between
insiders in a firm and the outside investors, a negative relation should be expected
between size and cash holdings. We use the natural logarithm of total sales in 1983
prices as a proxy for the size of firms (SIZE).
Liquidity
We predict that there is a negative relation between the firms cash holdings and its
liquid assets. To the extent that firms can use other liquid assets besides cash when they
have cash shortfalls, these assets can be seen as substitutes for cash holdings. We use
the ratio of net working capital, minus cash to total assets (LIQ) as a proxy for liquid
asset substitutes.
Other control variables
Similar to other studies, we also control for dividend policy and capital expenditures
of firms (see, for example, Opler et al., 1999 and Dittmar et al., 2002). For dividend
policy we use a dividend dummy, DIVIDEND, which is equal to 1 if a firm pays
dividend for a given year. To control for the possibility that the firms cash holding
policy is simply a function of its capital expenditures, we include the ratio of capital
expenditures to total assets, CAPEX. The data on this variable for the UK firms were
missing and hence this variable was dropped from both the UK estimations and the
pooled regression analysis.
4. Empirical Methodology and Data
In the following, we describe the empirical methods used in the paper to investigate
the role of country-specific factors as well as firm-specific variables in determining cash
holdings.
Cross-sectional estimation
We begin our analysis by focusing on the question whether legal and ownership
characteristics affect cash levels of firms. For this purpose, we estimate a cross-
sectional cash model using the average values of each of the firm characteristics (except
12
variability and country-specific characteristics) over four years in an attempt to mitigate
problems that might arise due to short-term fluctuations or extreme values in one year.
We measure cash holdings (the dependent variable) in 2000 and the explanatory
variables over the period 1996-1999. This is done to control for the problem of
endogeneity. Using past values reduces the likelihood of observed relations reflecting
the effects of cash holdings on firm-specific factors (see Rajan and Zingales, 1995 for a
similar approach). However, this approach is not able to control for the potential biases
that can be caused by the presence of unobserved firm-specific fixed effects. This is
one of the reasons why we also use panel data techniques in our analysis. These
techniques are discussed next.
Static fixed effects estimation
The static fixed effects model of cash holdings takes the following general form
it t i it it it
it it it it it it
DIVIDEND SIZE MKTBOOK
CAPEX LDEBT LIQ LEV CFLOW CASH


+ + + + +
+ + + + + =
7 6 5
4 4 3 2 1
(1)
where i and t represent firms and time respectively. CASH is the dependent variable
defined as the ratio of cash and marketable securities to total assets.
i
and
t
represent
time-invariant firm-specific effects and firm-constant time effects respectively. It is
assumed that firm-specific effects
i
(firm-heterogeneity term) are unobservable but
have a significant impact on cash holdings. They change across firms but fixed for a
given firm through time. In contrast,
t
varies through time but is the same for all firms
in a given year, capturing mainly economy-wide factors.
To the extent that there are relevant unobservable characteristics in the underlying
model, estimated coefficients in a cross-sectional regression will be biased due to the
correlation generated between the regressors and error term. The extent to which these
unobserved effects remain relatively stable over time, one could control for them by
using a fixed-effects (within) estimator to obtain consistent coefficient estimates.
Accordingly, we estimate the static model by controlling for fixed firm-specific effects.
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Dynamic panel data estimation
The above static model implicitly assumes that firms can instantaneously adjust to
changes in the target cash structure. In this paper, we incorporate the view that there
may be delays in the adjustment process because of positive costs of adjustment. This
in turn causes the current cash structure to deviate from the desired one (for a discussion
in a capital structure context see, for example, Myers, 1984 and Fischer et al., 1989).
We investigate these issues by modelling the firms behaviour as a partial adjustment to
a target cash ratio.
Suppose that the unobservable target cash holdings ratio of firms, CASH
*
it
, is taken
to be a function of several variables, K, and a disturbance term !
it
.
it
k
kit k it
x CASH + =

*
(2)
Firms adjust their cash holdings in order for their current cash ratio to be close to the
target one. This leads to a partial adjustment mechanism given by
) (
1 ,
*
1 ,
=
t i it t i it
CASH CASH CASH CASH (3)
where CASH
it
is the actual cash ratio. (CASH
*
it
-CASH
i,t-1
) can be interpreted as the
target change whereas only a fraction of it is achieved. The value of the adjustment
coefficient lies between 0 and 1, capturing the ability of firms to adjust to their target
cash levels. For example, if =1, it follows that firms are able to adjust immediately,
i.e. CASH
it
= CASH
*
it
, implying that adjustment costs are negligible.
Combining (2) and (3) yields

+ + =
1
1 , 0
k
it kit k t i it
u x CASH CASH (4)
where
0
=1-,
k
=
k
, and u
it
=
it
. (where u
it
has the same properties as !
it
). Finally,
also including
i
and
t
, the dynamic specification takes the following form
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it t i it it it it
it it it it it it
u DIVIDEND SIZE MKTBOOK CAPEX
LDEBT LIQ LEV CFLOW CASH CASH
+ + + + + +
+ + + + + =



9 8 7 6
5 4 3 1 1 0
(5)
The presence of the lagged dependent variable in (5) makes allowance for the
adjustment of the dependent variable to the target cash ratio. Firm-specific fixed effects

i
are controlled by the first-difference transformation and firm-invariant time effects
t
are captured by including time dummies in all panel data estimations.
Estimation problems
Despite its appeal, the above dynamic specification involves several estimation
problems. First, CASH
i,t-1
is correlated with time-invariant
i
even if the idiosyncratic
component of the error term are serially uncorrelated. Moreover, the first-difference
transformation to control for
i
introduces correlation between the lagged dependent
variable and differenced errors, i.e. CASH
i,t-1
and u
it
are correlated through terms
CASH
i,t-1
and u
i,t-1
, and hence OLS does not consistently estimate the coefficient
parameters.
Another estimation problem that also applies to the static model is the potential
violation of the assumption of strict exogeneity of regressors. Shocks affecting cash
structure can, for example, also affect some of the regressors such as market value of
equity and leverage. Moreover, it is likely that some of the regressors may be correlated
with the past and current values of the idiosyncratic component of disturbances.
The problems outlined above advocates the use of an Instrumental Variables (IV)
estimation method, where the lagged dependent variable and endogenous regressors are
instrumented using an appropriate set of instrumental variables. To do so, we employ
the GMM method of estimation which provides consistent parameter estimates (see
Arellano and Bond, 1991). The twice-lagged values of endogenous variables, x
k,it-2
, are
used as instruments in the analysis. The validity of instruments depends on the absence
of higher-order serial correlation in the idiosyncratic component of the error term.
Therefore, a test for the second-order serial correlation is reported. We also report the
statistic for the Sargan test of overidentifying restrictions.
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Data
For our empirical investigation we use a sample of listed firms from Japan, France,
Germany and UK over the period 1983-2000 (except for Germany for which the starting
year is 1987). There are mainly two reasons why we limit our analysis to these
countries. First, as discussed earlier, there is evidence that these countries differ widely
in terms of institutional and legal characteristics. Analysing cash holdings for these
countries may shed more light on the importance of these factors. Second, we were able
to construct panel data for listed firms in these countries. This has enabled us to carry
out a more thorough empirical investigation including the target adjustment analysis of
cash holdings.
Our initial sample is the set of all firms for which data are available on the
Datastream database, which provides both accounting data for firms, and market value
of equity. Firms, which operate in the financial sector, were excluded. Missing firm-
year observations for any variable in the model during the sample period were dropped.
Finally, from these firms, only those with at least five continuous time series
observations during the sample period were chosen. These criteria have provided us
with a total number of 3,989 firms, which represents 50,676 firm-year observations.
The structure of panel data constructed for each country is described in Table 2.
[INSERT TABLES 2 AND 3 HERE]
Table 3 reports the descriptive statistics for the main variables used in our analysis.
The average cash-to-asset ratio is highest for Japanese firms, 19.4 percent, and lowest
for German firms, 9.4 percent. These findings are in line with those reported in
previous research (Pinkowitz and Williamson, 2001; and Weinstein and Yafeh, 1998).
Higher corporate cash holdings in Japan is explained by the incentives of banks to act at
the expense of non-bank firms by encouraging them to hold relatively high levels of
cash (Pinkowitz and Williamson, 2001). Although Germany has also a bank-based
financial system, existence of supervisory boards with monitoring role can play a role in
preventing firms from extracting rents from firms. Alternatively, existence of large
share blocks in Germany might contribute to lower agency costs of debt since large
16
shareholders have greater incentive to monitor the firms. Relatively easy access to
capital markets would reduce incentive of firms to accumulate cash.
For UK and France, average cash-to-asset ratio is 10.3 percent and 12.3 percent,
respectively. One could provide at least two explanations for the relatively higher cash
ratio in France. First, it is argued that French managers maintain relatively greater
control over firms and have an independent approach while making financial decisions
(see, for example, Cobham and Serre, 2000). If this is the case higher cash holdings can
help managers maintain their independent approach. Second, relatively weaker
protection of investors and creditors in France can lead to problems in raising external
capital and force firms to rely more on internal finance.
5. Results
Country effects
Table 4 presents the first set of cross-sectional results. The dependent variable is
measured in 2000 and all the regressors (except VARIABILITY) are four-year averages
over the period 1996-1999. In the first column, we present OLS results for the pooled
regression where, in addition to firm-specific characteristics and industry dummies,
country dummies are incorporated to test the null hypothesis that cash holdings of firms
do not significantly change across countries. The UK is the base country in the
analysis.
The preliminary findings show that except for Germany there is a significant country
specific component to firms cash holdings. The Japan and France dummy variables are
positive and significant at 1 percent level, suggesting that Japanese and French firms
hold more cash than British and German firms. This is consistent with the results from
Table 1. The pooled regression results also indicate that firms cash holdings increase
with market-to-book value and decrease with cash flow, leverage, liquidity and size.
There is, however, no evidence to support the view that an increase in cash flow
volatility increases firms incentives to accumulate more cash. We are also unable to
provide evidence of significant impact of debt maturity on cash levels.
[INSERT TABLE 4 HERE]
17
In columns 2 to 5, we examine the results for each country separately. The results
with respect to leverage, liquidity and growth opportunities remain similar to what they
were in the pooled regression analysis. The relationship between cash holdings and
leverage is negative and significant at 1 percent level in all countries. Liquidity as
expected has a negative and significant impact on firms cash holdings for all countries.
Consistent with the prediction, the effect of growth opportunities on cash holdings is
positive and significant in France, UK, and Japan. In line with the hypothesis of
financing hierarchy model specifying internal finance as the least costly financing form,
cash holdings are negatively related to capital expenditures. Finally, the coefficient
estimate for dividend dummy is insignificant for all countries except Germany. In
Germany dividend paying firms hold more cash.
There are, however, findings that appear to change across countries and deviate from
those provided by the pooled regression analysis. For example, the impact of CFLOW
is negative and significant only for the UK. Another result that is not in line with that
provided earlier is that of the estimated coefficient of SIZE. In all countries except
Japan larger firms hold less cash. The estimated coefficient for France is, however,
insignificant. For France, Germany, and Japan there is a negative association between
cash holdings and capital expenditures. Also, there is a significant and positive
relationship between maturity of debt and cash holding only in France.
Finally, variability in cash flow (VARIABILITY) has insignificant effect in all
countries except Japan. This finding is not consistent with the prediction that firms with
more volatile cash flows are expected to hold more cash in an attempt to mitigate the
expected costs of liquidity constraints.
Legal and institutional effects
In Table 5, we continue to carry out our investigation cross-sectionally. However, in
order to be able to incorporate legal and institutional characteristics into the analysis, we
focus on pooled-regression analysis. In the first column, in addition to firm-specific
factors and industry dummies, we start by including the ownership variable
(Ownership) only. In column 2, we also add the proxy for the quality of law
18
enforcement (Rule of law). Finally, in column 3, we replace Rule of law by more
specific indicators, namely Anti-director rights and Creditor protection.
[INSERT TABLE 5 HERE]
Overall, the results suggest that legal and institutional characteristics play an
important role in determining cash levels o firms. More specifically, the impact of
ownership concentration is significantly negative and remains so under all
specifications. The negative effect may reveal that large shareholders are able to
influence managerial incentives to hold excessive amounts of cash and reduce the
expected agency costs. This would in turn reduce the costs of external financing and
hence lead to lower amounts of cashes holdings. The results also indicate that firms
hold lower level of cash in countries with high degree of shareholder protection (high
value of anti-director rights). As reported in column 3, the estimated coefficient of Anti-
director rights is negative and significant at 1 percent level. As also explained in
Section 2, a possible explanation for this result would be that high degree of shareholder
protection would lower the agency costs associated with external equity finance and
lead to much less reliance on internal financing.
As mentioned earlier, we argue that creditor protection may have different
implications for cash holdings of firms than shareholder protection has. To test this
view, we incorporate in the analysis a measure of the quality of protection creditors
receive in a country, Creditor protection. We find that, similar to the effect of Rule of
law, creditor protection exerts a positive and significant effect on firms cash holding
decisions. The positive relationship may indicate that the likelihood of bankruptcy for
financially distressed firms is higher in countries with higher law enforcement and
creditor protection. In other words, the threat of bankruptcy in financial distress is more
real. If this is the case, it is reasonable for firms to hold higher cash reserves as
precaution to avoid financial distress.
Dynamic effects
Turning to the GMM estimation results, Table 6 reveals that the coefficient of the
lagged cash holdings, CASH
i,t-1
, is positive and significantly different from zero for all
19
countries. For the UK, the adjustment coefficient that is given by
1
1 is greater than
0.6 suggesting that UK firms adjust their cash holdings relatively quickly in an attempt
to reach the target cash level. The evidence suggests that the dynamic nature of our
model is not rejected. This can be taken as a support to the view that firms trade-off
between costs of adjustment towards target cash holdings and costs of being off target.
For France, Germany and Japan, the adjustment coefficient is approximately 0.5,
possibly suggesting that the cost of being off target France, Germany and Japan is
relatively lower than that of UK. Alternatively, it may suggest that adjustment costs are
higher resulting in lower speeds of adjustment. The lower speed of adjustment for
Japan and Germany can be explained by the fact that German firms and Japanese firms
have close ties with their banks and depend on them for external financing. It is feasible
for them to adjust slowly towards their target level without incurring a high level of
agency cost. Overall, the results lend strong support to the dynamic nature of the cash
holding decision of firms. Firms tend to trade-off between costs of speedy adjustment
and costs of delay in achieving the target cash structure.
[INSERT TABLE 6 HERE]
The majority of our findings with respect to control variables are consistent with the
predicted results. Compared with the cross-sectional findings reported above, however,
there are notable differences. For example, the impact of leverage and size for Japan
changes significantly. The substitution effect of leverage does not exist anymore. In
contrast, the relationship between cash holdings and leverage becomes positive and
significant at 1 percent level. It seems that the disadvantages of leverage in terms of
higher probability of financial distress outweigh its advantages arising from being a
substitute for cash. Moreover, SIZE now exerts a negative and significant influence on
cash holdings of Japanese firms. The extent to which smaller firms are more likely to
be liquidated in financial distress, this finding also points out to the importance of
precautionary motives in determining cash levels of firms in Japan. Finally, in contrast
to the previous finding, the significant effect of debt maturity is observed only for UK
and Japan. The relationship is significant at only 10 percent level of significance
though. For others, it is insignificant.
20
There may be several reasons why there is a wedge between our estimation results
from GMM and from cross-sectional estimation method. Firstly, the data used in the
GMM analysis is over the period 1983-2000 while it is over the period 1996-2000 for
the cross-sectional analysis. Secondly, and more importantly, the endogeneity problem
can contribute to that wedge. As discussed previously, one is better equipped to control
endogeneity problem using the GMM method of estimation than cross-sectional
estimation methods.
[INSERT TABLE 7 HERE]
To complete our empirical analysis, in Table 7 we present for comparison purposes
the estimation results for fixed effects model. Although all the firm specific variables
have significant coefficient estimates one should exercise caution in interpreting these
results. This is because, as we discussed in the previous section, fixed effects
estimation method does not take into consideration the existence of potential
endogeneity problem that seems to be of crucial importance in cash holding regressions.
6. Summary and Conclusions
In this paper we analyse firms cash holding decisions by using firm-level data from
Japan, France, Germany and UK over the period 1983-2000. There are at least two
important features of our analysis, which, we believe, extend our understanding of the
cash holding behaviour of firms. First, we focus on the importance of corporate
governance issues. In doing so, we incorporate into the analysis legal and institutional
characteristics such as rule of law index, ownership concentration, degree of creditor
protection. To the best of our knowledge, this paper is the first to use these indicators in
this context. We argue that strong rule of law and creditor protection increase the
probability of bankruptcy in financial distress, which would in turn imply more
accumulation of cash as a precaution to avoid financial distress. Also, we argue that to
the extent that large shareholdings lead to a reduction in the cost of external finance,
firms would be expected to hold less cash in countries with higher ownership
concentration.
21
Second, we utilise a partial target-adjustment model to investigate target cash
holdings and how firms across countries differ in their speed of adjustment to the target
cash level. To do so, we use Generalised Method of Moments (GMM) estimation
method that enables us to control for the potential endogeneity problem more
effectively.
We observe that institutional and legal characteristics as well as firm specific
characteristics play a significant role in determining cash holdings of firms. We find
that existence of strong shareholders rights has a negative impact on cash holdings.
This implies that in countries with better shareholder protection firms have relatively
easier access to external equity, which would in turn reduces the reliance on internal
financing. However, creditor protection and law enforcement have the opposite effect.
The results possibly suggest that stronger creditor rights and better law enforcement
increase the likelihood of bankruptcy in financial distress. Thus, firms in an attempt to
lower the probability of bankruptcy increase their cash holdings.
The findings of our analysis also suggest that there are significant dynamic effects in
the determination of cash holdings and unobserved firm heterogeneity is significant.
22
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25
Table 1
Institutional and legal characteristics
Ownership
Concentration
Creditor rights Anti-director
rights
Rule of law
France 0.24 0 2 1.22
Germany 0.50 3 1 1.57
UK 0.15 4 4 1.59
Japan 0.13 2 3 1.61
For each country ownership concentration denotes the median ownership by the three largest shareholders
for the 10 largest non-financial firms. Creditor rights denotes an index aggregating creditor rights. The
index ranges from 0 to 4. Anti-director rights is an index aggregating shareholder rights and ranging from 0
to 5. Rule of law is an assessment of the law and order tradition in the country. Scale from 0 to 10, with
lower scores for less tradition for law and order.
Source: La Porta et al. (1997)
Table 2
Structure of unbalanced panel data
Number of years Number of firms
France Germany UK Japan
5
6
7
8
9
10
11
12
13
14
15
16
17
18
32
10
19
16
17
13
4
11
8
10
29
4
7
69
21
21
12
13
19
28
35
67
157
116
236
182
142
103
80
64
97
93
85
86
82
72
93
394
42
20
26
10
14
21
42
64
360
63
50
47
605
78
Total No. of firms 249 489 1809 1442
This table gives the structure of panel data for each country in our sample. The sample period is 1983-
2000 except for Germany for which it is 1987-2000.
26
Table 3
Descriptive statistics for main variables.
Mean Min 25% Median 75% Max
France
CASH 0.123 0 0.047 0.084 0.171 0.591
CFLOW 0.080 -0.862 0.053 0.082 0.116 0.387
LEV 0.242 0.0002 0.119 0.228 0.349 0.896
LIQ 0.004 -0.306 -0.094 0.008 0.110 0.489
LDEBT 0.547 0 0.338 0.570 0.770 1
MKTBOOK 1.723 0.663 1.057 1.261 1.780 9.508
SIZE 14.898 10.375 13.507 14.689 16.105 19.081
CAPEX 0.042 0 0.003 0.014 0.040 0.506
Germany
CASH 0.094 0 0.015 0.049 0.128 0.819
CFLOW 0.073 -0.600 0.044 0.084 0.123 0.246
LEV 0.196 0 0.030 0.147 0.315 0.785
LIQ 0.123 -1.394 -0.014 0.130 0.273 0.996
LDEBT 0.457 0 0.098 0.491 0.760 0.978
MKTBOOK 1.606 0.407 1.067 1.294 1.713 12.682
SIZE 12.519 4.614 11.292 12.543 13.945 18.473
CAPEX 0.083 0 0.033 0.069 0.113 0.272
UK
CASH 0.103 0 0.012 0.055 0.140 1
CFLOW 0.081 -1.084 0.054 0.090 0.128 0.443
LEV 0.174 0 0.060 0.156 0.253 0.775
LIQ 0.058 -0.989 -0.60 0.053 0.180 0.749
LDEBT 0.432 0 0.058 0.437 0.738 1
MKTBOOK 1.645 0.195 0.970 1.274 1.814 15.014
SIZE 9.071 2.197 7.821 8.927 10.209 16.224
J apan
CASH 0.194 0.0007 0.115 0.172 0.251 0.763
CFLOW 0.231 -0.187 0.008 0.021 0.040 0.181
LEV 0.301 0 0.152 0.285 0.426 0.912
LIQ -0.045 -1.063 -0.143 -0.042 0.058 0.485
LDEBT 0.441 0 0.220 0.431 0.646 1
MKTBOOK 1.480 0.510 1.058 1.284 1.653 10.534
SIZE 18.387 14.388 17.435 18.184 19.208 23.550
CAPEX 0.063 0 0.029 0.051 0.083 0.569
CASH is the ratio of total cash and equivalent items to total assets. CFLOW is the ratio of pre-tax profit
plus depreciation to total assets. LEV is the ratio of total debt to total assets. LIQ is the ratio of current
assets minus total cash and equivalent to total assets. LDEBT is defined as the ratio of debt that matures
in more than one year to total debt. MKTBOOK is the ratio of book value of total assets minus the book
value of equity plus the market value of equity to book value of assets. SIZE is the log of total sales in
1983 prices (1987 prices for Germany). CAPEX is the ratio of capital expenditures to total assets.
27
Table 4
Cash holdings regression results average cross-sectional estimation
Dependent variable: CASH
Pooled France Germany UK Japan
CFLOW
LEV
LIQ
LDEBT
CAPEX
MKTBOOK
SIZE
DIVIDEND
VARIABILITY
Japan
France
Germany
2
R
-0.1640
***
(0.0601)
-0.2446
***
(0.0158)
-0.0815
***
(0.0153)
0.0069
(0.0096)
0.0157
***
(0.0034)
-0.0031
**
(0.0014)
-0.0085
(0.0080)
0.0112
(0.0097)
0.1172
***
(0.0142)
0.0436
***
(0.0116)
0.0088
(0.0102)
0.21
-0.0093
(-0.1035)
-0.2429
***
(0.0750)
-0.1687
***
(0.0528)
0.0640
**
(0.0312)
-0.2238
**
(0.0940)
0.0198
**
(0.0093)
-0.0074
(0.0051)
0.0018
(0.0227)
-0.1418
(0.1816)
0.24
-0.0365
(0.0904)
-0.1640
***
(0.0364)
-0.0534
**
(0.0254)
0.0118
(0.0246)
-0.2967
*
(0.1633)
-0.0026
(0.0077)
-0.0072
*
(0.0040)
0.0314
*
(0.0171)
0.0065
(0.0089)
0.14
-0.2256
**
(0.0928)
-0.2084
***
(0.0442)
-0.1141
***
(0.0266)
-0.0129
(0.0181)
0.0093
**
(0.0047)
-0.0047
*
(0.0026)
-0.0241
(0.0248)
0.1152
(0.0743)
0.17
-0.0821
(0.0831)
-0.2801
***
(0.0204)
-0.0857
***
(0.0260)
0.0076
(0.0139)
-0.1520
***
(0.0591)
0.0209
***
(0.0064)
0.0043
**
(0.0021)
-0.0023
(0.0089)
0.5493
***
(0.1266)
0.28
CASH is the ratio of total cash and equivalent items to total assets. CFLOW is the ratio of pre-tax profit
plus depreciation to total assets. LEV is the ratio of total debt to total assets. LIQ is the ratio of current
assets minus total cash and equivalent to total assets. LDEBT is defined as the ratio of debt that matures in
more than one year to total debt. MKTBOOK is the ratio of book value of total assets minus the book
value of equity plus the market value of equity to book value of assets. SIZE is the log of total sales in
1983 prices (1987 prices for Germany). CAPEX is the ratio of capital expenditures to total assets.
DIVIDEND is equal to 1 if a firm pays dividend for a given year. VARIABILITY is the standard deviation
of the first difference in cash flows scaled by the average book value of total assets. Industry dummies are
included in all models.
***
,
**
and
*
indicate coefficient is significant at the 1, 5 and 10 percent level,
respectively.
28
Table 5
Cash holdings and institutional factors: pooled regression results
Dependent variable: CASH
CFLOW
LEV
LIQ
LDEBT
MKTBOOK
SIZE
DIVIDEND
VARIABILITY
Ownership
Rule of Law
Anti-director rights
Creditor protection
2
R
-0.2326
***
(0.0588)
-0.2459
***
(0.0159)
-0.0772
***
(0.0153)
-0.0131
(0.0096)
0.0147
***
(0.0033)
0.0071
***
(0.0007)
-0.0179
**
(0.0081)
0.0059
(0.0088)
-0.1200
***
(0.0203)
0.19
-0.1732
***
(0.0600)
-0.2411
***
(0.0157)
-0.0799
***
(0.0152)
0.0032
(0.0096)
0.0154
***
(0.0034)
-0.0029
**
(0.0015)
-0.0077
(0.0080)
0.0121
(0.0096)
-0.4636
***
(0.0443)
0.2538
***
(0.0326)
0.21
-0.1640
***
(0.0601)
-0.2446
***
(0.0158)
-0.0815
***
(0.0153)
0.0069
(0.0096)
0.0157
***
(0.0034)
-0.0031
**
(0.0014)
-0.0085
(0.0080)
0.0112
(0.0097)
-1.468
***
(0.1625)
-0.1368
***
(0.0168)
0.0244
***
(0.0042)
0.21
CASH is the ratio of total cash and equivalent items to total assets. CFLOW is the ratio of pre-tax profit
plus depreciation to total assets. LEV is the ratio of total debt to total assets. LIQ is the ratio of current
assets minus total cash and equivalent to total assets. LDEBT is defined as the ratio of debt that matures
in more than one year to total debt. MKTBOOK is the ratio of book value of total assets minus the book
value of equity plus the market value of equity to book value of assets. SIZE is the log of total sales in
1983 prices (1987 prices for Germany). CAPEX is the ratio of capital expenditures to total assets.
DIVIDEND is equal to 1 if a firm pays dividend for a given year. VARIABILITY is the standard deviation
of the first difference in cash flows scaled by the average book value of total assets. Industry dummies are
included only in all models.
***
,
**
and
*
indicate coefficient is significant at the 1, 5 and 10 percent level,
respectively.
29
Table 6
Dynamic cash holding regressions - GMM estimations
Dependent variable: CASH
France Germany UK Japan
CASH
it-1
CFLOW
LEV
LIQ
LDEBT
CAPEX
MKTBOOK
SIZE
DIVIDEND
Correlation 1
Correlation 2
Sargan test (df)
0.4415
***
(0.0608)
0.1471
(0.0912)
-0.0581
(0.0586)
-0.1909
**
(0.0854)
0.0146
(0.0294)
-0.5268
**
(0.2371)
-0.0039
(-0.0088)
-0.0305
(0.0184)
0.0048
(0.0259)
-5.46
0.76
85.11
0.4441
***
(0.0624)
-0.0254
(0.0330)
-0.1923
***
(0.0468)
-0.1335
***
(0.0662)
0.0218
(0.0208)
-0.4211
***
(0.1506)
-0.0152
(0.0121)
0.0057
(0.0150)
-0.0058
(0.0219)
-5.65
1.08
46.81
0.3975
***
(0.0391)
0.0249
(0.381)
-0.1614
***
(0.0616)
-0.4608
***
(0.1051)
0.0280
*
(0.0164)
0.0117
***
(0.0044)
-0.0051
(0.0083)
0.1098
***
(0.0337)
-13.35
-0.72
101.1
0.4385
***
(0.0391)
-0.1608
(0.1095)
0.2282
***
(0.0599)
0.0409
(0.0803)
0.0446
*
(0.0232)
-1.0423
***
(0.1968)
0.0044
*
(0.0024)
-0.0515
**
(0.0235)
0.1194
***
(0.0203)
-12.18
-0.79
81.42
CASH is the ratio of total cash and equivalent items to total assets. CFLOW is the ratio of pre-tax profit
plus depreciation to total assets. LEV is the ratio of total debt to total assets. LIQ is the ratio of current
assets minus total cash and equivalent to total assets. LDEBT is defined as the ratio of debt that matures in
more than one year to total debt. MKTBOOK is the ratio of book value of total assets minus the book
value of equity plus the market value of equity to book value of assets. SIZE is the log of total sales in
1983 prices (1987 prices for Germany). CAPEX is the ratio of capital expenditures to total assets.
DIVIDEND is equal to 1 if a firm pays dividend for a given year. Time dummies are included in all
regressions. Standard errors robust to heteroscedasticity are reported in parentheses. Correlation 1 and 2
are first and second order autocorrelations of residuals respectively, distributed as standard normal N(0,1)
under the null of no serial correlation; Sargan test is the test of overidentifying restrictions, distributed as
chi-square under the null of instrument validity. CASH
it-2
, CFLOW
it-2
, LEV
it-2
, LIQ
it-2
, LDEBT
it-2
,
CAPEX
it-2
(except for the UK), MKTBOOK
it-2
, SIZE
it-2
, and DIVIDEND
it-2
are used as instruments.
***
,
**
and
*
indicate coefficient is significant at the 1, 5 and 10 percent level, respectively.
30
Table 7
Cash holdings regression - fixed-effects estimation
Dependent variable:CASH
Pooled France Germany UK Japan
CFLOW
LEV
LIQ
LDEBT
CAPEX
MKTBOOK
SIZE
DIVIDEND
2
R
0.055
***
(0.011)
-0.172
***
(0.011)
-0.159
***
(0.025)
0.033
***
(0.003)
0.004
***
0.001
-0.016
***
(0.001)
0.010
***
(0.010)
0.72
0.160
***
(0.026)
-0.157
***
(0.016)
-0.334
***
(0.017)
0.074
***
(0.007)
-0.290
***
(0.026)
-0.003
***
(0.002)
-0.031
***
(0.003)
0.026
***
(0.005)
0.22
0.026
**
(0.013)
-0.164
***
(0.011)
-0.064
***
(0.005)
0.009
**
(0.005)
-0.970
***
(0.019)
-0.012
***
(0.002)
-0.007
***
(0.002)
0.003
(0.003)
0.10
0.073
***
( .007)
-0.283
***
0.006)
-0.243
***
(0.006)
0.030
***
(0.002)
0.004
***
(0.001)
-0.025
***
(0.001)
0.015
***
(0.002)
0.16
0.151
***
(0.012)--
0.102
***
(0.006)
-0.281
***
(0.006)
0.059
***
(0.002)
-0.389
***
(0.013)
-0.002
***
(0.001)
0.039
***
(0.002)
0.011
***
(0.002)
0.02
CASH is the ratio of total cash and equivalent items to total assets. CFLOW is the ratio of pre-tax profit plus
depreciation to total assets. LEV is the ratio of total debt to total assets. LIQ is the ratio of current assets
minus total cash and equivalent to total assets. LDEBT is defined as the ratio of debt that matures in more
than one year to total debt. MKTBOOK is the ratio of book value of total assets minus the book value of
equity plus the market value of equity to book value of assets. SIZE is the log of total sales in 1983 prices
(1987 prices for Germany). CAPEX is the ratio of capital expenditures to total assets. DIVIDEND is equal to
1 if a firm pays dividend for a given year. Time dummies are included in all regressions.
***
,
**
and
*
indicate
coefficient is significant at the 1, 5 and 10 percent level, respectively.