Coporate Finance 2

Mid-term test
03_NguyenHoangAnh_11190255
Question 1 (5 marks):
The more the company's scale develops, the more complicated the administration and operation
of the organization gets, according to the increasingly modern development trend as well as the
variety of company types. This is a dilemma for business owners because they will be unable to
successfully manage their company. The emergence of hypotheses regarding the connection
between owners and agents is based on this (hired company managers - managers). Economic
theory, created by Alchian and Demsetz in 1972 and further expanded by Jensen and Meckling
in 1976, is the foundation of agency theory. Since then, this has become standard practice when
researching agency cost issues. The impact of agency costs on a firm's capital structure, which
will be examined in this article, is an essential problem highlighted in this theory.
An agency relationship is a contract in which one or more individuals (the principal(s)) hire
another individual (the agent) to perform some service on their behalf, which includes delegating
some decision-making authority to the agent. The agency costs were defined as the sum of the
principal's monitoring expenses, the agent's bonding expenses, and the residual loss (Jensen and
Mecking, 1976). The costs of a conflict of interest between stockholders and management are
referred to as agency costs. These expenses can be either indirect or direct. An indirect agency
cost represents a missed opportunity. There are two types of direct agency costs. The first type of
corporate expenditure is one that benefits management but costs stockholders. Perhaps the
purchase of a luxurious and unnecessary corporate jet falls under this category. The second type
of direct agency cost is a cost incurred as a result of the need to monitor management actions
(Stephen A. Ross, Randolph W. Westerfield and Bradford D. Jordan). The content of these two
definitions is very similar, but the arrangement and classification are not. As a result, we will use
both definitions to assess the impact on a firm's capital structure. Dare and Sola (2010) define
capital structure as the debt-equity mix of business finance. It's a symbol for the proportionate
relationship between debt and equity in a company's financial statements. As a result, in this
context, capital structure refers to the mix of equity and debt in a company's capital. This is
consistent with Chou's (2007) characterization of a company's debt and equity funding. An
optimal capital structure is a company's ideal debt/equity ratio, which reduces financing costs
while increasing the firm's value.
First and foremost, the agency cost theory asserts that an optimal capital structure can be
achieved by lowering the expenses incurred as a result of conflicts between managers and
owners. The leverage level, according to Jensen and Meckling, can be used to monitor managers'
efforts to pursue the overall firm's goals rather than their own. As a result, costs are lowered,
resulting in increased efficiency, which will ultimately improve firm performance (Buferna et al.,
2005). Take a look at the illustration below.
The expansion path would also be represented by OZBC if the management got outside money
and the agency connection had no expenses (possibly because monitoring costs were zero). As a
result, this approach represents what we would call "idealized" solutions, or those that would
arise if agency costs were not there. Assume the management has enough personal money to
fully fund the company only up to investment level I1, putting him at point Z. W = I1 at this
point. To expand the firm beyond this point, he will need to get outside finance to cover the
additional investment, which will necessitate a reduction in his fractional ownership. He incurs
agency costs as a result of this, and the lower his ownership share, the higher the agency costs.
However, if the projects that require outside finance are profitable enough, his net worth will
continue to rise.
This makes sense because high agency costs indicate that the owner-agency manager's conflict
with outside shareholders, which stems from the manager's proclivity to steal perquisites from
the firm's resources for his own consumption, is raging. Indeed, the most substantial dispute is
likely to stem from the fact that as the manager's ownership claim diminishes, so does his desire
to commit major effort to innovative activities like finding new profitable projects. He may avoid
such enterprises since managing or learning about new technology needs too much work or effort
on his behalf. Avoidance of these personal costs and the anxieties that go with them also
represent a source of on-the-job utility to him and it can result in the value of the firm is
substantially lower than it otherwise could be.
I will look at the model of Hayne E. Leland (1998) as a second example to show how agency
costs affect firm value. Agency costs are the percentage difference in firm value between optimal
ex-ante asset choice, where the firm cannot transfer value from creditors to shareholders through
asset substitution, and ex-post asset choice, where creditors face costs from asset substitution.
Even when a firm's risk policy can be committed ex-ante to maximize firm value, the firm
increases risk when asset value is low; when the risk choice is made after assets are in place, the
firm has significantly higher average risk, illustrating the asset substitution problem. The
existence of bankruptcy and reorganization expenses, which helps to explain why debt does not
entirely dominate capital structures. The costs of the agency are quite low, at around 1.37 percent
- less than a sixth of the tax benefits associated with debt. Creditors, on the other hand, are
concerned about the possibility of asset substitution. With no agency charges, the yield spread is
69 basis points (bps); with agency fees, the yield spread rises to 108 bps. In comparison to an
otherwise equivalent firm (one that can precontract risk levels before debt is granted, avoiding
asset substitution risk for the creditor), the firm with agency expenses has lower optimal leverage
and a shorter loan maturity. When the risk policy of the company is established once the loan is
in place, the company will switch to a high-risk level with a considerably higher asset value.
Contrary to popular belief, asset substitution occurs even when agency costs are absent, but to a
smaller extent than when they are present.

The third section discusses the impact of agency costs on debt. The enterprise's financial
situation will have a direct impact on its capital structure. In the event of a lack of capital and the
desire to increase working capital, the enterprise must decide which source to supplement, if the
enterprise chooses to use The capital structure of the business will be in favor of using debt, but
if the business has accumulated capital to provide for business activities, the enterprise will use
additional capital without borrowing capital. Thus, whether or not to borrow will be determined
by the business's financial capacity. Whether or not to employ debt is decided by the manager's
point of view. In reality, some managers are eager to take on debt in order to boost profitability,
while others are wary. As a result, the manager's perspective is critical in producing a profit.
Make this choice. The entire wealth consequences of the agency costs of debt are borne by the
owner-manager, and he captures the advantages from decreasing them. In the absence of other
mitigating variables, the agency costs associated with debt discourage the use of corporate debt.
What about the factors that make it more likely to be used? One factor is the interest payment tax
credit. Even if these tax benefits were not available, debt would be used if the owner's capacity to
exploit potentially profitable investment possibilities was limited by his or her resources. From a
sociological standpoint, this method is ideal.
The final impact of agency costs that I need to specify is the impact on the sum of cash the
company holds, which comes from traditionalist administration. A risk – averse executive will
attempt to store a part of cash fair in case of instabilities that will happen to the company's
operations when there are truly no speculation openings. The shareholders at that point need the
executive to pay more profits or purchase back offers of the trade.
To summarize, both the law and the sophistication of contracts applicable to modern
corporations are the result of a historical process in which people have great incentives to reduce
agency costs. The representative, in theory, should be able to handle the agreement's objects
better than the firm owners. However, because business ownership and management are
separated, "the directors of these businesses become the financial managers of others... carelessly
and wastefully," rather than "really seriously as business owners handle their own capital," "the
directors of these businesses become the financial managers of others... carelessly and
wastefully" (Smith, 1776). This is a problem that all businesses have faced and will continue to
encounter.
Question 2 (5 points):
Due to the competitive financial environment, the importance of efficient and effective cash
management procedures has been a major research topic in recent years. Corporate financial
policies concerning financial behavior, dividend distribution, cash flow management, working
capital, and investment plans, according to Opler (1999), play a crucial role in corporate cash
management strategies, particularly in maintaining the appropriate amount of cash. Growth
potential, investment levels, research and development expenditures, cash flow, and cash flow
volatility are all positively related to a company's cash holdings. Firm size, leverage, net working
capital, and a dividend dummy variable are all negatively related with cash holdings.
I will start by stating what I know and my thoughts on the advantages and disadvantages of
holding cash in the firms. A basic thing we all know is that Cash is the most common asset that
businesses utilize to pay bills, pay their debts and operating expenditures, such as taxes,
employee wages, inventory purchases, advertising costs, and rentals, among other things. Cash is
utilized as a source of investment capital for long-term assets including property, plant, and
equipment (PP&E) and other non-current assets. Excess cash after expenses is frequently used to
fund dividend distributions. To ensure adequate company stability, companies with a variety of
cash inflows and outflows must be carefully handled.
I. Motives and benefits of holding cash in the corporate
So what are the motives and benefits of holding cash in the business?
1. Motivations of holding cash in the corporate
John Maynard Keynes, in his classic work The General Theory of Employment, Interest, and
Money, identified three motives for liquidity: The speculative motive, the precautionary motive,
and the transaction motive.
THE SPECULATIVE AND PRECAUTIONARY MOTIVES
The speculative motive is the desire to keep cash on hand in order to take advantage of
opportunities such as bargain purchases, low interest rates, and (in the case of foreign
companies) beneficial exchange rate changes. Reserve borrowing ability and marketable
securities can be leveraged to satisfy speculative purposes for most businesses. Thus, keeping
liquidity may have a speculative motivation, but not necessarily storing cash. Consider this: If
you have a credit card with a high credit limit, you may likely take advantage of any
extraordinary offers that arise without having to carry any cash.
This is also true, to a lesser extent, for precautionary motives. The necessity for a backup supply
to serve as a financial reserve is the precautionary reason. Maintaining liquidity, once again, is
most likely motivated by prudence. However, because the value of money market instruments is
reasonably predictable, and products like T-bills are extremely liquid, there is no actual need to
keep large sums of cash on hand as a safety net.
THE TRANSACTION MOTIVE
The transaction incentive, the requirement to have cash on hand to pay bills, necessitates the use
of currency. The firm's usual disbursement and collection activities generate transaction-related
needs. Wages and salaries, trade debts, taxes, and dividends are all examples of cash
disbursement.
Cash is obtained by product sales, asset sales, and fresh loans. Because cash inflows (collections)
and outflows (disbursements) are not completely coordinated, certain cash holdings are required
as a buffer.
With the continued development of electronic funds transfers and other high-speed, "paperless"
payment mechanisms, the transaction demand for cash may all but vanish. Even if it does, there
will still be a need for liquidity and an efficient management of it.
COMPENSATING BALANCES
Another reason to keep cash is to compensate for balances. Cash balances are kept at commercial
banks to compensate for banking services received by the firm, as discussed in the previous
chapter. A minimum compensating balance requirement may impose a lower limit on a
company's cash holdings.
2. Benefits of holding cash in the corporate
So of course we can see that holding cash brings a lot of benefits to businesses. Ensuring normal
and continuous production and business activities, preventing all uncertainties occurring in the
business process, maintaining solvency, demonstrating financial stability and soundness of the
enterprise, abling to take advantage and realize the advantages when there are good additional
investment opportunities are those benefits that can be clearly seen when the enterprises hold
cash.
If businesses do not keep a penny, they will not be able to maintain production, have no money
to buy input materials, no money to pay salaries and wages, no money to hire or buy assets,...
That case will be terrible, the entire production and business activities of the enterprise will
freeze, and the consequences will be…, because without production, where does the business get
products to sell? If you don't sell products, where do you get revenue and profit? Can the
business be maintained? There is a proverb: “Money is the blood of a business, a bad director is
the director who has no money for his business”. Therefore, keeping money helps businesses
help businesses circulate production and business activities, maintain production lines, or even
expand production whenever there are opportunities in the market.
Once again I want to emphasize that businesses keep money to maintain liquidity and then, to
maintain solvency, demonstrate financial stability and soundness of the enterprise. Liquidity of
an enterprise is the solvency of that enterprise at each point in time. This manifests in the use of
current assets such as cash, inventory, accounts receivable, securities and current assets to meet
current liabilities. Excess cash (that coporate holding) presenting on the balance sheet helps a
coperation manage its cash flow efficiently. The excess cash comes to the rescue if there is a
sudden dip in revenue or delays in account receivables. The excess cash ensures that the
organization is able to meet its obligations, such as pay bill, payroll, rent, administration
expenses and loan payments, even if it doesn't generate any revenue for a specified period.
Make the case that you are a newly launched business. New entrepreneurs are encouraged to
keep excess cash on hand as a buffer to meet day-to-day obligations in case the onboarding of
new clients takes time. The excess cash on the balance sheet ensures that the organization isn't
forced to borrow money. Since borrowing costs are high, organizations should maintain some
excess cash on hand to avoid taking short-term loans. Excess cash on hand is an indication of the
short-term financial well-being of the business.
Moreover, let's say on a good day the market presents you with a super bargain, super profitable
investment. But at that time, you were the director of the business, you didn't hold a penny of
cash in your hand. So you missed an opportunity. Sorry isn't it? So as I mentioned above,
holding cash help corporate with the ability to take advantage of and realize the benefits when
there are good additional investment opportunities.
Holding cash also help the corporate in early payment to the supplier to enjoy the trade discount.
The cost of not accepting commercial discounts is often very high, so businesses need to have
enough money to take advantage of payment opportunities to enjoy discounts.
Another benefit of holding cash is that Help businesses maintain a better credit rating than peers
thanks to higher current and quick ratios. A high credit rating allows businesses to enjoy more
favorable purchasing conditions and maintain low credit costs from banks.
Businesses should keep cash to respond to emergencies such as strikes, fires or launching
stronger marketing campaigns than competitors, and when the business cycle is down due to
seasonality or because the decline of the economy.

 I want to talk about another issue, I will temporarily call the benefit of holding money in
attracting investors.
First, it seems that investors are always looking for businesses with abundant cash on the balance
sheet, because they believe that a lot of cash will help businesses handle easily if the The
business plan is deteriorating and it also gives the business more choice in finding investment
opportunities in the future.
Investors are not inside the business, so usually seeing a lot of cash items on the balance sheet is
always more reassuring than businesses with less cash. Especially when over the quarters, or
over the years, the amount of cash increases steadily and stably, it is a signal that the business is
doing very well and is developing very strongly. Cash accumulates so quickly that managers do
not have time to plan how to use it most effectively.
Microsoft is an example. In the software manufacturing industry, perhaps the name of Microsoft
is known worldwide. Microsoft is doing so well that its annual cash flow is always more than
$40 billion. As revenue continued to grow strongly and cash kept growing rapidly. Other
successful businesses in industries such as software and service production, entertainment, and
media typically do not require as much capital expenditure as companies in capital-intensive
industries.
II. Cost of holding cash in the corporate
That's not to say it's always good to have more cash than the theory suggests. Everything has a
cost, and so does the business holding cash. So in the next part I will give my researches and
views on the cost of holding cash that businesses have to face.
We will focus on the following 3 main problems that when holding cash, businesses will face:
- Incurring management costs.
- Affected by inflation and exchange rate changes.
- Loss of opportunity cost of cash capital.
When a firm holds cash in excess of some necessary minimum, it incurs an opportunity cost. The
opportunity cost of excess cash (held in currency or bank deposits) is the interest income that
could be earned in the next best use, such as an investment in marketable securities. For
example, instead of holding cash, a business can invest money in profitable financial assets, buy
assets, or deposit it in the bank for periodic interest. Thus, the business not only owns that
money, but also adds a profit from bringing the money to invest or deposit.
Moreover, holding cash will cause businesses to pay more money to manage the cash in hand,
even spend more effort and manpower. “Possession is nine - tenths of the law.” Anyone who
owns money will all preserve and cherish it carefully. However, the money in the hand of the
business is always a very large amount, which means that the cost of cash management will be
large (including the cost of buying a safe, the cost of hiring a treasurer, the cost of building a
warehouse, money preservation,etc.)
Inflation is undesirable for any business holding cash. Today's 1 dollar is different from
yesterday's 1 dollar. Today's 1 dollar can buy 100 units of input materials but tomorrow's 1 dollar
can only pay 10 units. Therefore, the devaluation of the currency is the cost that corporates must
pay for holding cash.
III. I want to add one more part - Financial theories about behavior of firm’s cash
holding - which will concerned with citing the relationship between holding money
and other components in the part IV
In determining the behavior of firm’s cash holding, grounding theories which remained more
pertinent to cash management practices of firms include trade off, pecking order and free cash
flow theory (Wasiuzzaman, 2014).
1. Trade-off theory
According to the tradeoff theory, firms maintain the optimal level of cash at the breakeven point
where the marginal cost and benefit of holding cash are equal (Al-Najjar, 2011; Martínez-Sola et
al., 2011). As pointed out by Opler (1999), based on Keynes (1936), benefits of holding cash are
derived from two vital motives: Precautionary and transaction motive. Hence, when firms
considered the marginal benefits and cost of holding liquid assets, trade off perspective in cash
management practices supported the optimal level of cash.
2. Pecking order
In contrast, another significant theory in line with cash management practices of firms is pecking
order. This theory was grounded by the Myers (1984) and Myers and Majluf (1984). In line with
this theory, firms first prefer the internal financing to finance their investment plans by utilizing
the liquid assets and retained earnings. After that, debt is issued while, issuance of equity is
considered as the last resort. On one side, pecking order theory supported that firms with high
profits would mostly finance the investment plans with internal resources therefore, these firms
tend to hold high cash ratio.
3. Free Cash Flow Theory
In contrast, the free cash flow theory by Jensen (1986) described that managers preferred to hold
higher cash level to enhance the volume of total assets in their control. They also tried to gain the
distinctive powers in the firm’s investment and financing decisions. As a result, this behavior
affects the shareholder’s wealth negatively. Therefore, the optimal level of cash holding is
considered as a significant problem in the shareholder-manager situation.

IV. Relationship between cash holdings and growth opportunities, investment

levels, research and development expenditures, cash flow, and cash flow
volatility (positive)

Relationskip between cash holdings and firm size, leverage, net working capital
and a dividend dummy variable (negative)

1. Positive relationship
1.1. Cash holdings – Growth opportunities
Companies with greater growth opportunities hold more cash and value it more than others, as
financial constraints are more costly for these companies (Bates et al., 2009). As a result, the
level of cash is expected to vary positively with respect to a company's growth opportunity. We
used the ratio between market value and book value (total assets minus net equity, plus company
market value, divided by total assets) as a proxy for growth opportunity, as Bates et al. (2009),
Chang and Noorbakhsh (2009), Ozkan and Ozkan (2004), and Opler et al. (1999) did.
According to most studies, firms with higher growth opportunities have a higher level of cash
holdings because such firms are more likely to hold more cash reserves in order to capitalize on
opportunities. Kim et al. (1998), for example, argued that firms with high growth opportunities
have larger cash reserves. Bigelli and Sánchez-Vidal (2012) found comparable results in private
firms. They claimed that because private firms have fewer internal funds, they are more likely to
underinvest. As a result, private firms have more cash on hand for future growth opportunities.
The majority of empirical studies show that growth opportunities have a positive effect on cash
holdings. Therefore, we expect the association between cash holdings and growth opportunities
to be positive.
Growth has a positive effect on cash holdings
1.2. Cash holdings – Investment levels
When corporates hold more cash, they will have the opportunity to invest more. And the more
money they hold, the greater the investment, of course, because when the investment bargain
comes, we already have money in hand, ready to seize the opportunity.
From a financial perspective, investing is the process by which an investor spends a certain
amount of assets to gain future benefits of the item investment items. For investing
activities, the investment decision of the company is narrowly defined as the process by
which the company spends a certain amount of capital funding in an investment item such as
buying fixed assets or using costs to invest in any form to obtain benefits or increasing
the amount of capital. The investment decision is a decision related to the value of assets and the
value of each asset component including fixed assets and current assets. In the wide mean, to
achieve a certain benefit in the future with the aim of maximizing profits, the company is willing
to spend capital and spend on human resources to invest.
According to Modigliani-Miller's (1958) study, in a perfect capital market, domestic capital and
external capital are a perfect alternative. The company's investment decision is independent of its
financial status. However, in reality, internal capital and market capital are not an ideal
substitute, but the investment can be influenced by other factors such as financial leverage,
internal cash flow, company's value, capital size (Arikawa et al, 2003). ZhangChao Lin (2018)
argue that the cash holding ratio of each company has a significant impact on the
company's investment. In the FHP study (1988), asymmetric information was argued and
proved that cash flow strongly influenced investment. Ozkan (2002) also argued that cash
holdings is an essential factor affecting the company’s development thus the company needs
to determine the amount of cash necessary. Scholars then investigated the relationship
between the company's existing cash and investment decisions. But with different data
collection scopes or different study periods, so the conclusions of the scholars are not
the same: cash holdings has a positive, opposite or U-shaped effect on investment level.
Therefore, I expect the association between cash holdings and investment level to be positive.
Cash holdings and investment levels have a positive relationship.
1.3. Cash holdings – Research and development expenditures
Nowadays, with the demand of foreign market keeps down and the promotion of fixed-asset
investment is limited, technological innovation is increasingly important. The sound combination
of industry and technology is the basis and guarantee of enterprises’ sound operation. The reform
of property and operating mechanism are continuously deepening and the R&D investment is
increasingly important in listed companies especially high-tech listed companies. It have seen the
significant influence of cash holdings on enterprise’s R&D investment as well as the positive
effect of high amount of cash holdings on R&D investment based on the theories of New
Institutional Economics and accordingly propose corresponding suggestions for further
technological innovation, upgrade of products and improvement of core competitiveness. So,
let’s say that:
R&D investment has a positive effect on cash holdings
1.4. Cash holdings – Cash flow
Companies with higher cash flows accumulate more cash (Bates et al., 2009). Thus, it is
expected that the level of cash will vary positively with a company’s cash flow. Following Bates
et al. (2009) and Opler et al. (1999), we define cash flow as earnings after interest, tax and
dividends, but before depreciation.
The tradeoff theory indicates a negative association between cash holdings and cash flow, since
firms that generate more cash flows from operations require fewer cash reserves. In contrast, the
pecking order theory notes a positive association between cash reserve and cash flow. It suggests
that firms generating more cash flows are likelier to hold more cash to use for investments and
during periods of financial distress. Extant empirical studies also report both positive (Opler et
al. 1999; Ozkan and Ozkan 2004; Uyar and Kuzey 2014) and negative (Chen 2008) effects of
cash flow on cash holdings. Since most studies document a positive effect, I agree that:
Cash flow has a positive effect on cash holdings
1.5. Cash holdings – Cash flow volatility
Opler et al. (1999) and Bates et al. (2009) found an association between increased cash flow
volatility and increased levels of cash retained by companies.
The tradeoff theory posits that firms with high uncertainty of cash flow are likely to hold more
cash. Therefore, the association between cash flow uncertainty and cash holdings is positive.
Most empirical literature has also reported a positive association between cash flow and
uncertainty thereof (see: Bigelli and Sánchez-Vidal 2012; Demir and Ersan 2017; Guney et
al. 2007; Kariuki et al. 2015; Shabbir et al. 2016). However, few studies do report a negative
effect of volatility on cash holdings (Ferreira and Vilela 2004; Paskelian et al. 2010). Thus, I
agree that:
Cash flow volatility has a positive effect on cash holdings
 2. Negative relationship
2.1. Cash holdings – Firm size
Economies of scale favor larger companies, which hold less cash (Bates et al., 2009; Mulligan,
1997). Moreover, large companies tend to be more diversified (Titman & Wessels, 1988) and
present less asymmetric information when compared to smaller companies. Thus, a negative
relationship between cash level and company size is expected. Following Chang and Noorbakhsh
(2009) and Foley et al. (2007), the logarithm of total assets was used as a proxy for company
size.
The trade-off theory postulates that large firms are stable, more profitable, and diversified. They
have constant stream of cash flows and low probability of bankruptcy. These features allow large
firms to hold fewer cash reserves. This indicates a negative association between cash holdings
and firm size. 
Size has a negative effect on cash holdings
2.2. Cash holdings – Leverage
If the debt is high enough, companies will use cash to reduce leverage, resulting in a negative
relationship between leverage and cash level (Bates et al., 2009). On the other hand, less
leveraged companies are less subject to external monitoring, which allows management to hold
more cash (M. A. Ferreira & Vilela, 2004). Acharya, Almeida and Campello (2007)
demonstrated that holding cash allows companies with limited access to capital markets to
protect themselves against future uncertainty, but debt reduction is the most efficient way of
raising future cash flows. Therefore, companies with limited access to capital markets prefer to
hold more cash rather than reduce their debts if the need to protect themselves is high, but they
prefer to reduce cash when there is less need for protection.
The trade-off theory postulates that firms with high leverage ratio also have higher risk and are
likely to face bankruptcy. Therefore, high-leverage firms hold more cash reserves to prevent
such situations. In such conditions, we note a positive association between leverage and cash
ratio. In contrast, the pecking order theory postulates a negative association between leverage
and cash flow, suggesting that leverage can be used as a proxy for issuing debt. Hence, debt can
substitute holding cash, and firms holding more liquid assets can convert these assets into cash
easily. Therefore, leverage and cash flow are characterized by a negative association (Opler et
al. 1999). Majority of studies predict a negative effect of leverage on cash holdings (see:
Chen 2008; Opler et al. 1999; Ozkan and Ozkan 2004; Shabbir et al. 2016; Uyar and
Kuzey 2014). Thus, I agree that:
Leverage has a negative effect on cash holdings
2.3. Cash holdings – Net working capital
Other net assets can be used to replace company cash (Ozkan & Ozkan, 2004) as long as they
can be easily converted to cash. Net working capital is made up of assets that serve as cash
substitutes (Bates et al., 2009). As a result, we anticipate a negative relationship between net
working capital and assets and cash holdings. Net working capital to assets is defined as current
assets minus cash and short-term investments divided by total assets.Thus, I agree that:
Net working capital and cash holdings have a negative relationship

2.4. Cash holdings – A dividend dummy variable

Companies that pay dividends tend to take fewer risks and have greater access to capital markets
(Bates et al., 2009). Companies that pay dividends can afford to keep less cash on hand because
they are better able to raise funds when needed by cutting dividends (M. A. Ferreira & Vilela,
2004). We define the dividend dummy as 1 if the company pays dividends and 0 if it does not,
following Bates et al. (2009), Ozkan and Ozkan (2004), and Opler et al. (1999). Thus, I gree that:
Dividend dummy variable has a negative effect on cash holdings