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Corporate Governance, Product Market Competition,
Corporate Diversification and Value of Cash Holding.
(A Doctoral Dissertation PhD-Finance)
Faculty of Management Sciences
INTERNATIONAL ISLAMIC UNIVERSITY
ISLAMABAD
Researcher
Idrees Ali Shah
Reg No. 37-FMS/PHDFIN/S11
Supervisor
Dr. Syed Zulfiqar Ali Shah
Associate Professor
International IslamicUniversity
Islamabad
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Corporate Governance, Product Market Competition,
Corporate Diversification and Value of Cash Holding
(A Doctoral Dissertation PhD-Finance)
Idrees Ali Shah
Registration No. 37-FMS/PHDFIN/S11
Submitted in partial fulfillment of the requirements for the
PhD degree with specialization in Finance
at the Faculty of Management Sciences
International Islamic University
Islamabad.
Supervisor ( Febuary, 2018)
Associate Professor
Dr. Syed Zulfiqar Ali Shah
International Islamic University Islamabad
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In the name of Allah, the most merciful and beneficent
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DEDICATION
“To my father Mian Gul Badshah, my mother, my supervisor Dr. Syed
Zulfiqar Ali Shah and to my teachers, for their unconditional love, prayers and
support to make my dreams come true.”
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ABSTRACT
The purpose of this research is to investigate effect of corporate governance on
different facets of cash management i-e, level of cash holding, value of cash holding,
utilization of excess cash and performance. Furthermore, the role of product market
competition is checked in the relationship of corporate governance with different facets of
cash management and to get more detail analysis role of family ownership and Shariah
compliance is also checked. The research also investigated effect of corporate
diversification on value of cash holding in strong governed firms and poorly governed
firms; competitive and concentrated industries; family and non-family firms; Shariah and
non-Shariah compliant firms.
The study used unbalanced panel data of 196 companies from the years 2006 to
2014. All models generally include time dummies and industry fixed effect with standard
error cluster to firm. The result shows that corporate governance has significant negative
effect on corporate cash holding which supports flexibility hypothesis. Moreover, corporate
governance has significant positive effect on value of cash holding and performance of firm
through efficient utilization of excess cash due to corporate governance. The role of product
market competition is explained in the context of substitution and complementary effect
argument. The results generally support complementary effect of product market
competition for corporate governance in all relationship with cash management and
performance except with level of cash holding that support substitution effect. Substitution
effect claim that external market discipline alone is enough mitigate agency problem. On the
other hand, complementary hypothesis claim that external market discipline need efficient
internal governance to mitigate agency problem.
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Family firms have high agency problem compared to non-family firms and corporate
governance leads to proper utilization of excess cash that leads to high value of cash holding
and performance in family firms. The dissertation also investigated effect of corporate
governance on different facets of cash management in Shariah compliant firms and non-
Shariah compliant firms. The result portray that corporate governance has no significant
effect on level of cash holding. The result postulates insignificant effect on value of cash
holding and utilization of excess cash in Shariah compliant firms which support substitution
effect of Shariah compliance for corporate governance. Excess cash under good governance
has same effect on performance in Shariah and non-Shariah compliant firms and the result
does not support agency theory.
The result also indicates that corporate diversification decreases value of cash
holding due to agency problem. However, it increases value of cash holding in good
governed firms compared to poorly governed firms. Similarly, it increases value of cash
holding in competitive industries compared to concentrated industries because external
market discipline mitigate agency problem. On the other hand, corporate diversification
decreases value of cash holding in family firms, while it has significant effect on value of
cash holding in Shariah compliant firms.
Key words: Corporate governance, Cash holding, Value of cash holding, Competition,
Diversification, Family ownership, Shariah compliance, Pakistan.
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COPY RIGHT
© Idrees Ali Shah (2018).All rights reserved. No part of this Thesis may be reproduced without the
permission of the copyright holder.
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DECLARATION
I hereby declare that this thesis, neither as a whole nor as a part thereof, has been copied out from
any source. It is further declared that I have prepared this thesis entirely on the basis of my personal
effort made under the sincere guidance of my supervisor.
No portion of work, presented in this thesis has been submitted in support of any application for any
degree or qualification of this or any other university or institute of learning.
Idrees Ali Shah
PhD (Finance)
Faculty of Management Sciences
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ACKNOWLEDGEMENT
I would like to extend my sincere appreciation and gratitude to all those people and
especially to teachers who directly or indirectly helped me in this dissertation.
I would also like to extend my honest and truthful appreciation and thanks for mother and
my father Mian Gul Badshah for his endless and everlasting support in my study and future career. I
strongly confess that without his support and moral courage I would not be in a position to complete
this degree.
Special thanks are also due to my supervisor, Dr. Syed Zulfiqar Ali Shah for his precious
time, valuable insight and expert guidance. His patience, encouragement and faith in my abilities
have motivated me and allowed me to grow as a researcher. I specially appreciate his friendly and
supporting style of supervision which allowed me to preserve and accomplish my aim despite many
difficulties and challenges, without his guidance and support this would not have been possible.
I am also very thankful to Higher education commission of Pakistan (HEC) for giving me
PhD scholarship and financial support of my PhD degree. With the support of HEC I completed my
PHD and I improved my communication, behaviors, and educational skills.
I am very thankful to my wife and my daughter Meerab Shah and Manha Shah for their
sacrifice. I also pay my special thanks to my colleagues Mr. Nouman, Mr. Salam, Dr. Tazeem Ali
Shah and Mian Rehmanuddin to help me in my theses. I am also thankful to Mr. Naeem Ullah, Dr.
Sheraz Ahmad, Dr. Habib Ahmad, Mr. Shafiq, Mr. Sabee Ullah, Dr. Imran Saeed, Mr. Yaseer
Mahmood and Mr Hazrat Jan for their encouragement to complete this dissertation.
Idrees Ali Shah
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Table of content
ABSTRACT .................................................................................................................................... v
LIST OF TABLES ........................................................................................................................ xiv
Abbreviation .................................................................................................................................. xv
CHAPTER 1 .................................................................................................................................... 1
INTRODUCTION ........................................................................................................................... 1
1.1Background of the study .......................................................................................................... 1
1.2 Gap Identification ................................................................................................................. 17
1.2Problem statement ................................................................................................................. 22
1.4 Objectives of the study ......................................................................................................... 25
1.5 Research Questions .............................................................................................................. 27
1.6 Significance of the Study ...................................................................................................... 28
1.7 Significance in Pakistani context .......................................................................................... 30
1.8 Contextual Contribution ....................................................................................................... 33
1.9 Theoretical contribution ....................................................................................................... 35
1.10 Delimitation of Research .................................................................................................... 37
1.11 Organization of Study ......................................................................................................... 37
CHAPTER 2 .................................................................................................................................. 38
LITERATURE REVIEW ............................................................................................................... 38
2.1 Corporate governance and Cash holding ............................................................................... 38
2.1.1 Corporate governance, Product market competition and cash holding............................. 44
2.1.2 Corporate governance, Family ownership and Corporate cash holding ........................... 45
2.1.3 Corporate governance, Shariah compliance and Cash holding ........................................ 48
2.2 Corporate governance and value of cash holding .................................................................. 49
2.2.1 Corporate governance, Product market competition and Value of cash holding .............. 53
2.2.2 Corporate governance, Family ownership and Value of cash .......................................... 55
2.2.3 Corporate governance, Shariah compliance and Value of cash holding .......................... 56
2.3 Excess cash and Usage ......................................................................................................... 57
2.3.1 Corporate governance and uses of excess cash ............................................................... 58
2.3.2 Corporate governance, Product market competition and Uses of excess cash .................. 61
2.3.3 Corporate governance, Family firms and Uses of excess cash ......................................... 63
2.3.4 Corporate governance, Shariah compliance and Uses of excess cash .............................. 66
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2.4 Excess cash, corporate governance, and Total factor productivity growth.............................. 66
2.4.1 Excess cash, Corporate governance, Product market competition and Total factor
productivity growth ................................................................................................................ 68
2.4.2 Excess cash, Corporate governance, Family ownership, and Total factor productivity
growth.................................................................................................................................... 70
2.4.3 Excess cash, Corporate governance, Shariah compliance, and Total factor productivity
growth.................................................................................................................................... 71
2.5 Corporate governance, Diversification and Value of cash ..................................................... 73
2.5.1 Corporate diversification, product market competition, and value of cash holding .......... 75
2.5.2 Corporate diversification, Family firms and Value of cash holding ................................. 76
2.5.3 Diversification, Shariah compliance, and value of cash holding ..................................... 77
2.6 Theoretical framework ......................................................................................................... 77
CHAPTER 3 .................................................................................................................................. 82
METHODOLOGY ........................................................................................................................ 82
3.1 Population and Sample size .................................................................................................. 82
3.2 Variables of the study ........................................................................................................... 83
3.2.1 Cash Holding ................................................................................................................. 83
3.2.2 Corporate governance measurement ............................................................................ 83
3.2.3 Diversification measurement.......................................................................................... 85
3.2.4 Product market competition ........................................................................................... 86
3.2.5 Control variables ........................................................................................................... 86
3.3 Panel data analysis ............................................................................................................... 88
3.3.1 Static model ................................................................................................................... 88
3.3.2 Dynamic model ............................................................................................................. 89
3.4 Analytical model .................................................................................................................. 90
3.5 Value of Cash holding .......................................................................................................... 91
3.6 Analytical model for spending excess cash ........................................................................... 93
3.7 Analytical model for governance and total factor productivity growth ................................... 94
3.7.1 Total Factor Productivity Growth................................................................................... 94
CHAPTER 4 .................................................................................................................................. 97
RESULT AND DISCUSSION ....................................................................................................... 97
4.1 Effect of corporate governance on Cash holding ................................................................... 97
4.1.1 Corporate governance and Cash holding ...................................................................... 101
4.1.2 Effect of product market competition on the corporate governance and cash holding
relationship .......................................................................................................................... 103
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4.1.3 The effect of concentration on corporate governance and cash holding relationship ...... 105
4.1.4 Effect of corporate governance on cash holding in family and non-family firms ........... 106
4.1.5 The effect of corporate governance on cash holding in Shariah compliant firms ........... 107
4.1.6 Control of Endogeneity ................................................................................................ 108
4.2 Effect of corporate governance on Value of Cash holding ................................................... 113
4.2.1 Determinates of value of cash holding.......................................................................... 117
4.2.2 Corporate governance and value of cash ...................................................................... 118
4.2.3 The effect of corporate governance on value of cash holding in competitive and
concentrated industries ......................................................................................................... 119
4.2.4 The effect of corporate governance on value of cash holding in family and non-family
firms .................................................................................................................................... 121
4.2.5 Effect of corporate governance on value of cash holding in Shariah compliant and non
Shariah compliant firms ....................................................................................................... 123
4.3 Effect of corporate governance and excess cash on industry adjusted capital expenditure .... 124
4.3.1 Effect of excess cash on industry capital expenditure in good governance firms ........... 126
4.3.2 Effect of corporate governance on excess cash and industry adjusted capital expenditure
relationship in competitive and concentrated industries ......................................................... 128
4.3.3 Effect of corporate governance on excess cash and industry adjusted capital expenditure
relationship in family and non-family firms .......................................................................... 129
4.3.4 Effect of corporate governance on excess cash and industry adjusted capital expenditure
relationship in Shariah compliant and non-Shariah compliant firms ..................................... 130
4.4 Effect of corporate governance on excess cash and dividend relationship ............................ 131
4.4.1 Effect of excess cash with good governance on dividend .............................................. 133
4.4.2 Utilization of excess cash in the form of dividend under good governance in competitive
and concentrated industries ................................................................................................... 134
4.4.3 Utilization of excess cash in the form of dividend under good governance in family and
non-family firms .................................................................................................................. 135
4.4.4 Utilization of excess cash in the form of dividend under good governance in Shariah
compliant and non- Shariah compliant firms ........................................................................ 136
4.4.5 Effect of corporate governance on excess cash and corporate diversification relationship
............................................................................................................................................ 137
4.5 Role of product market competition, family ownership and Shariah compliance on utilization
of excess cash .......................................................................................................................... 143
4.6 Effect of corporate governance on excess cash and firm performance relationship .............. 149
4.6.1 Role of corporate governance on excess cash and total factor productivity growth
relationship .......................................................................................................................... 150
4.6.2 Effect of excess cash with good governance on total factor productivity growth in
competitive industries........................................................................................................... 153
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4.6.3 Effect of excess cash with good governance on total factor productivity growth in family
firms .................................................................................................................................... 154
4.6.4 Effect of excess cash with good corporate governance on total factor productivity growth
in Shariah compliant firms.................................................................................................... 155
4.6.5 Effect of corporate governance on excess cash and industry adjusted ROA relationship155
4.7 Effect of diversification on value of cash holding................................................................ 158
4.7.1 Effect of corporate diversification on value of cash holding in good and poor governance
firms .................................................................................................................................... 162
4.7.2 Effect of corporate diversification on value of cash holding in competitive and
concentrated industries ......................................................................................................... 163
4.7.3 Effect of corporate diversification on firm value in family and non-family firms .......... 164
4.7.4 Effect of diversification on value of cash holding in Shariah compliant firms ............... 165
CHAPTER 5 ................................................................................................................................ 166
CONCLUSION ........................................................................................................................... 166
5.1 Practical Implications ......................................................................................................... 170
5.2 Limitation .......................................................................................................................... 171
5.3 Future direction .................................................................................................................. 172
REFERENCES ............................................................................................................................ 174
Appendix 1 .................................................................................................................................. 194
Appendix2 ................................................................................................................................... 197
Appendix 3 .................................................................................................................................. 199
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LIST OF TABLES
Table 3.1: Sample size ....................................................................................................... 83
Table 3. 2: Corporate Governance Variables ...................................................................... 85
Table 4. 1: Descriptive Statistics ........................................................................................ 98
Table 4.2: Effect of corporate governance on cash holding (Dependent variable: Cash
holding) ........................................................................................................................... 100
Table 4.3: Dynamic panel model GMM effect of corporate governance on cash holding .. 110
Table 4.4: Descriptive Statistics ....................................................................................... 113
Table 4.5: Effect of Corporate Governance on Value of Cash Holding ............................. 115
Table 4.6: Role of corporate governance and utilization of excess cash on industry adjusted
capital expenditure (Dependent variable ⊿Ind-capex) ...................................................... 125
Table 4.7: Role of corporate governance on excess cash and dividend relationship .......... 132
Table 4.8: Role of corporate governance on spending of excess cash in form of
diversification (dependent variable diversification) .......................................................... 138
Table 4.9: Role of competition, family ownership and Shariah on spending of excess cash
........................................................................................................................................ 144
Table 4.10: Role of corporate governance on excess cash and total factor productivity
growth relationship .......................................................................................................... 151
Table 4.11: Role of corporate governance on excess cash and Industry adjusted ROA
relationship ...................................................................................................................... 156
Table 4. 12: Effect of diversification on value of cashholding(dependent: excess return).. 160
Table 4.13: Determinants of cash holding ........................................................................ 195
Table 4.14: Effect of Competition Family ownership and Shariah Compliance on Total
Factor Productivity and operating profit ........................................................................... 197
Table 4.15: Effect of corporate governance on cash holding ............................................. 199
Table 4.16: Effect of corporate governance on cash holding in competitive industries ...... 199
Table 4.17: Effect of corporate governance on cash holding in family firms and Shariah
compliant firms ................................................................................................................ 200
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Abbreviation
Excess: Excess cash
Govindex: Corporate governance index
Gov: Governance dummy
Div: Dividend payment
Diver: Diversification dummy
TFPG: Total factor productivity growth
Comp: Competitive industries
Conc: Concentrated industries
Family: Family firms
Non-Family: Non family firms
Shariah: Shariah compliant firms
N-Shariah: Non Shariah compliant firms
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CHAPTER 1
INTRODUCTION
The first chapter introduces the dissertation and sets an overall context for the study.
It consists of background of the study, research gaps, problem statement, objectives of the
study, research questions, significant of the study, significance of the study in Pakistan
context, contextual contribution, and theoretical contribution.
1.1 Background of the study
Firms hold cash because the cost of internal financing is lower than the cost of
external financing. The pecking order theory suggests that equity financing is the most
expensive source of financing, while internal financing is the cheapest source of financing
(Modugo, 2013).
Keynes (1936) has discussed three motives of cash holding including the transaction
motive, precautionary and speculative motive. The transaction motive suggests that firms
hold cash to support day to day activities, while the precautionary motive shows that firms
hold cash to defend themselves from sudden external shocks. On the other hand, speculative
motive of cash explain that firms hold cash to avail sudden opportunities arising in the
market. Similarly, according to the financial friction argument firms hoard cash either to get
benefit of transactional economies of scale, or for precautionary motive, or to avoid under
investment (Mulligan, 1997; Opler, Pinkowitz, Stulz, & Williamson, 1999; Almeida,
Campello, & Weisbach, 2004).
However, the benefit of maintaining cash should be greater than the cost of hoarding
cash. The financial economics literature that considers the financial decision of corporate
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sector regarding liquidity, suggests that equilibrium is must between benefit of hoarding
cash as reserve for precautionary purpose and cost of hoarding cash particularly the agency
cost (Jain, Li, & Shao, 2013). Cash is prone to the agency problems since it can easily be
expropriated by entrenched managers and controlling shareholders for their personal benefit
on the cost of shareholders (Harford, Mansi, & Maxwell, 2008). Therefore, proper corporate
governance is needed to reduce agency problem and align interest of managers to the
interest of shareholders.
The cash holding pattern of the corporate sector is changing throughout the world. The
cash holding of US corporate sector has increased from 5% in 1990 to 13% in 2003 (Dittmar
& Mahrt-Smith, 2007). Harford et al. (2008); Jain et al. (2013) also shows that US firms
cash holding increases over time. USA public firms on average hold 18% in form of cash
and marketable securities (Gao, Harford, & Li, 2013). Hussain (2014) claimed that
corporate cash holding in Pakistan too has increased in the last decade due to high earning
of corporate sector. The managers mostly increase corporate cash holding in the wake of
increasing the viability of their firms. This is because in the crises period firms with
sufficient internal funds are more viable compared to the firms with insufficient funds
(Opler et al., 1999). Therefore, cash has gained more importance after the US Subprime
Mortgage crises (2007/2008).
There is now wide detection, as well as growing empirical evidence that corporate
governance arrangements can considerably affect shareholders wealth and corporate
decisions especially cash holding. Corporate governance is “the system through which
companies are directed and controlled" (Cadbury Committee, 1992). Under this system the
corporate objectives of the firms are set, which are then directed, monitored and achieved
with the help of corporate governance.
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Cash is type of asset which is easily expropriated compare to other type of assets
therefore; shareholders have a higher concern for cash compared to other assets. Since,
corporate governance allow outside investors to defend themselves from expropriation of
inside managers and controlling shareholders. Therefore, many studies including Dittmar,
Mahrt-Smith, and Serveas (2003); Pinkowitz and Williamson, (2004); Dittmar and Mahrt-
Smith (2007); Harford et al. (2008) indicate that the problem of under investment reduces
significantly in the presence of good governance and shareholders become less concerned
about the expropriation of cash reserves by mangers for their personal benefits.
The extant research provides insight into the different facets of the firms’ cash holding
and signifies the role of corporate governance in determining their cash holding decisions.
This dissertation adds to the extant literature by investigating the effect of corporate
governance on different facets of corporate cash holding in the context of Pakistan. There
are five important aspects of our study, which differentiate it from the previous
researches:
The first aspect of our study is to investigate the relationship between corporate
governance and cash holding, and to investigate the role of product market competition,
family ownership, and Shariah compliance in the relationship of corporate governance and
cash holding. Cash holding and corporate governance have gained significant importance in
the corporate finance literature.
Harford et al. (2008) concludes three hypotheses on effect of corporate governance and
cash holding including the flexibility hypothesis, spending hypothesis and shareholder
power hypothesis. According to flexibility hypothesis corporate governance is negatively
related to cash holding because due to agency problem managers hold cash to defend them
from external capital market discipline (Jensen, 1986). On the other hand, the spending
4
hypothesis claims that mangers disgorge cash on value reducing investments due to agency
problem. Therefore, agency problem is negatively related to corporate cash holding.
Shareholder power hypothesis on the contrary claims that shareholders trust managers and
allow them to hold cash to avoid under investment problem when agency problem is low.
The empirical researches on corporate governance and level of cash holding report
mixed results. For example, Harford et al. (2008) found positive relationship between
corporate governance and cash holding and shows that firms with good governance hold
more cash as compared to firms with poor governance. In contrast, Dittmar et al. (2003)
found negative relationship between corporate governance and cash holding using
international data. On the other hand, Kalcheva and Lins (2007) showed insignificant
relationship of corporate governance and cash holding. These divergent findings suggest
that the effect of corporate governance on the cash holding may be different across different
industries and ownership structures. To answer the question this study investigates the effect
of corporate governance on cash holding in competitive industries, family owned firms and
Shariah compliant firms.
The concept of product market competition and its effect on corporate decision is
deeply discussed in economics literature. Finance researchers have also discussed the effect
of degree and nature of competition in product market on cash flows of firm, investment and
choices of firm finances (e.g. Haushalter, Kalsa, & Maxwell, 2007; Xu, 2012; Hou &
Robinson 2006; Hoberg & Phillips, 2010). The role of product market competition in the
corporate governance and level of cash holding relationship is explained on the basis of two
arguments including the substitution effect argument and the complementary effect
argument. According to substitution effect argument competition works as external market
discipline to mitigate agency problem between managers and owners even firm level
governance is poor. Therefore, corporate governance do has low significance in competitive
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industries compared to the concentrated industries. In contrast, complementary hypothesis
shows that competition alone is insufficient to mitigate agency problems and need efficient
governance to mitigate the agency problem arising between shareholders and mangers.
Therefore, efficient governance is needed with external market discipline to mitigate agency
problems.
On the basis of theoretical model Hermalin (1992) argued that the bargaining power
of stockholders decreases agency problem and agents of the firms become sensitive to
competition in product market. Furthermore, he concluded that corporate governance is
complemented by competition. Padilla (2000); Januszewski, Koke, and Winter (2002);
Grosfeld and Tressel (2002) suggests that competition needs efficient corporate governance
to mitigate agency problem and corporate governance is complemented by competition. On
the other hand, the researchers like Holmstrom (1982); Nalebuff and Stiglitz (1983); Hart
(1983); Giroud and Mueller (2010, 2011); Guadalupe and Perez-Gonzalez (2010) found that
competition is a substitute for corporate governance and governance matters more in
concentrated industries than the competitive industries.
Another insight of this research is whether corporate governance has different effect
on corporate cash holding in family and non-family firms. Family ownership is an important
type of ownership in Pakistan and all over the world. Family ownership is increasing in
Pakistan in a sizable manner particularly in the unlisted firms. Family firms plays important
role in the promoting economy (La Porta, Lopez-DE-Silances, & Shilfer, 1999; Claessens,
Djankov, & Lang, 2006; Faccio & Lang, 2002; Anderson & Reeb, 2003a). Research on
corporate governance in family firms has got attention in the recent era especially on the
family firms’ control right in the perspective of corporate governance (Wei, Wu, Len, &
Chen, 2011). Family firms resolve classic agency problem between managers and
shareholders due to the concentration in the hands of family members. Family members
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want long run survival of the firm and actively monitor the activities of managers (Wei et
al., 2011; Villalonga, Amit, Trujillo, & Guzman, 2015). The mitigation of agency problem
between managers and shareholders due to ownership concentration become beneficial for
all shareholders. On, the other hand agency conflict between controlling shareholders and
minority shareholders are higher in family firms (Villalonga et al., 2015). Moreover, family
firms engage in family altruism and want to pass business to their successors and
expropriate cash to fulfill firm legacy (Kuan, Li, & Chu, 2011). So, corporate governance is
more important in family firms to monitor the activities of controlling shareholders.
Another type of firm structure gaining importance globally and Pakistan is not
exception is Shariah compliant firms. A firm has to pass certain screening criteria (i.e.,
Qualitative and Quantitative criterion) for inclusion in the Shariah compliant firms.
Qualitative criterion requires that core business nature should not be against Shariah e.g.
wine business, pork business, casino business etc. On the other hand, the quantitative
criteria include some financial ratio that should meet certain criteria set by Shariah
committee. For example, debt to asset ratio should be less than 37%, non-compliant
investments to asset ratio should be less than 33%, illiquid assets to total asset ratio should
be at least 25%, and non-compliance revenue to total revenue ratio should be less than 5%.
(“Shariah Methodology,”n.d.).
The extant literature suggests that Shariah compliant firms have low debt compared
to the non- Shariah firms. Since, low debt is substitute to corporate governance therefore;
Shariah compliance is a substitute to good governance due to low debt and other financial
criteria. Debt is used as external monitoring for managers and reduce agency problem
(Jensen 1986; Stulz 1990; Zwiebel, 1996). Firms with poor corporate governance have high
debt to mitigate agency problem and constraint mangers to waste the resources of firm
(Jiraporn, Kim, Kim, & Kitsabunnarat, 2012; Ullah & Rizwan, 2018). As, per agency theory
7
explanation firms with good governance don’t need high debt to mitigate agency problem.
Low levered companies are good governed and Shariah compliant firms have low debt
compared to non-Shariah compliant firms. Therefore, Shariah compliant firms have good
governance compare to its counterpart (Hayat & Hassan, 2017). Therefore, Shariah
compliant firms do not need high debt to control agency problem. Furthermore, Ullah and
Rizwan (2018) found that Shariah compliant firms work as alternative for corporate
governance. This shows that Shariah compliant firms have substitution effect on corporate
governance and cash holding relationship. Moreover, Shariah compliant firms have
advantage over non- Shariah compliant firms on the basis of tax reduction due to interest.
To avoid interest base financing Pakistan gives 2% tax rebate to Shariah compliant firms to
promote Shariah compliance (Shaikh, 2016).
The second aspect of our study is that whether corporate governance effects value of
cash holding. Moreover, the role of product market competition, family ownership, and
Shariah compliance in the relationship of corporate governance and value of cash holding is
investigated. The expropriation behavior of mangers and controlling shareholders destroy
firm value due to agency problem. Therefore, corporate governance improves firm value
through efficient utilization of excess cash. Good governance reduces agency problem and
increase firm value due to positive effect of good governance on stock prices and investor
perception. Moreover, in the presence of good governance, managers are unable to divert
firm cash flow to un-profitable project and board of directors willingly distributes cash in
form of dividend to existing shareholders and increase value of firm (Jensen & Meckling,
1976; La Porta et al., 2002). Similarly, good governance reduces cost of capital due to
reduction of supervision and auditing cost (Shleifer & Vishny, 1997).
The existence of agency problem and conflict between principal and agent
relationship destroy value of firm (Ditmar & Mahrt-Smith, 2007; Pinkowitz, Stulz, &
8
Williamson, 2006; Kalcheva & Lins, 2007; Jain et al., 2013). The previous studies show that
corporate governance positively affects value of firm due to efficient utilization of cash
(Yermack, 1996; Gompers, Ishii, & Metrick, 2003; Cremers & Nair, 2005; Core, Guay, &
Rusticus, 2006; Bebchuck, Cohen, & Farerell, 2009). However, few researchers are of the
view that it is inconclusive whether execution of proper governance affects firm value
because governance bears some cost that may outweigh the advantage of corporate
governance (e.g., Gillan & Starks, 2003; Chhaochharia & Grinstein, 2007; Bruno &
Claessens, 2010).
The empirical literature that shows effect of corporate governance on firm value,
dominantly measured firm value through Tobin Q (like Yermack, 1996; Kalcheva & Lins,
2007; Amman, Oesch, & Schmid, 2013). Tobin Q basically measures value of firm on basis
of total assets. However, according to Dittmar and Mahrt-Smith (2007) valuation of cash is
important instead of other type of assets to find out value effect of corporate governance.
The reason is that cash is easily expropriated by managers for their personal interest
compare to other types of assets and therefore, cash has very important position in overall
value of firm. Their study further point out that variation in cash is higher than the variation
in firm level governance. Therefore, powerful test is demanded to find out effect of
corporate governance on value of cash holding and uses of excess cash. Similarly, Dittmar
and Mahrt-Smith (2007) further shows that value of excess cash is almost twice in good
governance firms compared to poor governance firms due to efficient utilization of excess
cash in good governance firms. Keeping in view these suggestions the present study
investigates the effect of corporate governance on value of cash holding following the model
of Faulkender and Wang (2006). Their model uses change in cash for calculating firm value
instead of Tobin Q.
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The present study also investigates whether effect of corporate governance on value
of cash holding vary across different industries and ownership structures. Therefore, the
relationship of corporate governance and value of cash holding is tested in competitive and
concentrated industries, family and non-family firms, and Shariah compliant and non-
Shariah compliant firms.
The extant literature shows that competition works as a market discipline that
mitigates agency problem (Amman et al., 2013). Product market competition forces
managers to work in the best interest of shareholders (Alimov, 2014). According to
substitution effect corporate governance has insignificant effect on value of cash holding in
competitive industries compared to the concentrated industries. Product market competition
works as external market discipline that mitigate agency problem despite of firm poor level
governance and increase value of cash holding. Amman et al. (2011) found that corporate
governance has significant effect on firm value only in concentrated industries and their
result support substitution effect. Their study used proxy of total firm value measured
through Tobin Q instead of excess return. On the other hand complementary effect argument
suggest that corporate governance has significant effect on value of cash holding in
competitive industries because external market discipline needs efficient governance to
mitigate agency problem. Jain et al. (2013) shows that corporate governance has significant
effect on value of cash holding in competitive industries compare to concentrated industries
and shows complementary effect of product market competition for corporate governance in
relationship with value of cash holding.
Similarly, family ownership is also an important to consider because the corporate
sector of Pakistan is characterized by family ownership. Moreover, family firms have
significantly different structure compared to non-family firms. Therefore, the present study
also investigates the effect of corporate governance on value of cash holding in family and
10
non-family firms. Family ownership mitigates the conflicts between managers and
shareholders through keen supervision of the activities of managers.
However, the agency problem between controlling family shareholders and minority
shareholders is high in family firms (Shliefer & Vishney, 1997; Villalonga & Amit, 2006).
Thus the overall value of firm decreases due to conflict between controlling shareholders
and minority shareholders. Family firms face difficulty in raising funds through minority
shareholders, if the cost of minority shareholders conflict with majority family shareholders
is higher than the conflict between managers and shareholders (Puerto, 2010).
Family firms usually involve in the policies that benefit a particular family and
destroy overall firm value (Smith & Amoaka-Adu, 1999; Perez-Gonzalez, 2006; Bennedsen,
Nielsen, Perez-Gonzalez, & Wolfenzen, 2007). Previous studies recognize that the
appointment of a family successor as CEO or Chairman of a firm destroys performance and
value of firm. The reason is that families successors tend to miss-utilize the power of
corporate control for their own benefit (Volpin, 2002; Holderness, 2003; Enriques &
Volpin, 2007). This study contributes to existing literature by empirically examining the
effect of corporate governance on value of cash holding in family and non-family firms.
Recently, Shariah compliance has gained attention as the determinant of firm value
(Lusyana & Sherif, 2017). Value of cash holding is reduced due to agency problem because
excess cash is miss-utilized due to agency problem (Jain et al., 2013). Corporate governance
reduce agency problem and increase value of cash holding (Dittmar & Mahrt-Smith, 2007)
and Shariah compliance also plays the same role. Shariah compliant firms have different
structure from non-Shariah compliant firms (Amina, 2015). Shariah compliant firms follow
the principles of Shariah which is alternate to good governance. The effect of corporate
governance on firm value in Shariah compliant firms is ignored in the extant literature
11
though it is an important determinant of firm value. Therefore, the present study investigates
the effect of corporate governance on firm value in Shariah compliant and non-Shariah
compliant firms. The essence of modern corporate governance is to protect outsider
investors from insiders i.e., managers and controlling shareholders. Similarly, Islam does
not allow a person to get benefit on the expense of others and discourages the destruction of
the others’ wealth for personal benefit. Therefore, Shariah compliance is alternate to
corporate governance. Moreover, Shariah compliant firms have low interest bearing debts
compared to the non-Shariah compliant firms. Jensen (1986) claimed that low debt is
substitute to good governance. So, according to substitution effect argument Shariah
compliant firms have low agency problems and substitute for corporate governance.
Consequently, good governance has insignificant effect on value of cash holding as compare
to non-Shariah compliance firms.
The third aspect of our study is to investigate utilization of excess cash in the
presence of strong corporate governance. Furthermore, the study also investigated the role
of corporate governance on utilization of cash in competitive industries, family firms, and
Shariah compliant firms. Firm value is affected due to spending of excess cash i.e., if excess
cash is wasted in hands of managers and controlling shareholders the overall value of firm
decreases and vice versa. Extant research suggests that excess cash is wasted on value
destroying investments by mangers and controlling shareholders due to agency problems
and ultimately lower the economic performance of the firm and value of the firm (Dittmar &
Mahrt-Smith, 2007; Harford et al., 2008; Jain et al., 2013; Bena, Ferreira, Matos, & Pires,
2017).
Keeping in view these findings this dissertation investigates the effect of corporate
governance on spending of excess cash. This research considers three ways of spending
excess cash including capital expenditure, dividend payments, and diversification. Harford
12
et al. (2008); Jain et al. (2013) found that good governance reduce excess cash spending in
form of internal investment (measured through industry adjusted capital expenditure).
According to spending hypothesis managers and controlling shareholders disgorge excess
cash in the form of internal investment due to agency problems (Harford et al., 2008).
Corporate governance mitigates agency problem and restrains insiders from disgorging
excess cash on internal investments.
Second channel of disgorging cash is on dividend which is explained on the basis of
agency theory. Dividend payment reduces free cash flow in the hands of entrenched
mangers. Therefore, mangers are unable to spend excess cash for their own interest because
excess cash is distributed to the shareholders (Jensen & Meckling, 1976; Jensen, 1986). The
substitution model and outcome model provides two possible explanations for effect of
corporate governance and dividend. According to substitution model dividend is substitute
to corporate governance and posits negative relationship with corporate governance (Amina,
2015). On the other hand, outcome model suggest that whenever corporate governance is
good minority shareholders force management to distribute excess cash among shareholders
in form of dividend. Therefore, corporate governance and dividend shows positive
relationship on basis of outcome model (Amina, 2015).
The third way of disgorging excess cash is on corporate diversification. Research
shows that due to agency problem and empire building hypothesis, firms involve in
diversification and particularly the unrelated diversification which destroys overall value of
firm. The recent scandal in India is an example of such diversification where the chairman
of reputed company of United Breweries involved in diversification and started an airline
with brand name of King Fishers which resulted in the destruction of the firm value.
13
This dissertation also investigates whether the role of corporate governance on
spending of excess cash is same for all industries and ownership structures. To answer this
question the research investigated effect of corporate governance on spending of excess cash
in competitive and concentrated industries, family and non-family firms, and Shariah
compliant and non-Shariah compliant firms. Two approaches theoretically support the role
of governance on spending of excess cash in competitive and concentrated industries i.e.,
the substitution and complementary effect. According to substitution effect good governance
has no significant role in the utilization of excess cash in competitive industries as compared
to concentrated industries (Jain et al., 2013). On the other hand, the complementary
argument suggests that external market discipline needs good governance for efficient
utilization of excess cash in competitive industries (Amman et al., 2011). Research shows
that dividend as signal for good governance and firms with poor governance mitigate agency
problem through distribution of excess cash in form of dividend. Therefore, dividend is
comparatively higher in concentrated industries..
Similarly, Family firms also have divergent investment, dividend and diversification
behavior compared to non-family firms. In family firms the controlling shareholders of
particular family tree spend excess cash for their own interest and for the interest of
particular family members on the cost of minority shareholders (Kalcheva & Lins, 2007).
Therefore, to control agency problems between controlling shareholders and minority
shareholders proper governance is needed. Due to agency problems, family firms involve in
empire building and spend excess cash for creating a empire for themselves and for their
successors that ultimately destroy value of firm (Kuan et al., 2011). Good corporate
governance protects minority shareholders from expropriation of controlling shareholders in
family firms. Similarly, Shariah compliant firms have different financial strategies
compared to non-Shariah compliant firms. However, the role of corporate governance on
14
spending of excess cash in Shariah compliant firm is ignored in literature. As discussed
earlier Shariah compliant firms have low agency problems and are alternate to corporate
governance. Moreover, Shariah compliant firms have lower tendency to involve in value
reducing investments due to their structure. Therefore, according to substitution effect
argument good governance has insignificant effect on spending of excess cash in Shariah
compliant firms compared to non-Shariah compliant firms.
The fourth aspect of our study is to investigate the relationship between corporate
governance and firm performance, and to investigate the role of product market competition,
family ownership, and Shariah compliance in the relationship of corporate governance and
firm performance. Corporate governance increase performance of firms due to efficient
utilization of excess cash (Dittmar & Mahrt-Smith, 2007). Previous researches show that
excess cash under good governance increases operating profit of the company and vice versa
(like Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et al., 2013). The negative
effect of excess cash under poor governance on performance indicates that inefficient
spending of excess cash ultimately destroys value of firm.
In this research we adopted total factor productivity growth as a proxy for firm
performance instead of traditional accounting ratios. Productivity growth considers
maximum growth in vector of outputs with the same vector of inputs. Total factor
productivity growth considers the difference of both efficiency change and technology
change, while conventional method does not consider change in technology (Nishimizu &
Page, 1982). Total factor productivity is more appropriate approach to investigate the
performance instead of using accounting ratio alone because ratio may be manipulated by
managers (Tian & Twite, 2011; Barth, Gulbrandsen, & Schone., 2005). In this research we
used total factor productivity growth instead of total factor productivity because the
15
relationship of corporate governance and total factor productivity is prone to endogeneity
problem (koke, 2001).
Proper corporate governance forces managers to utilize resources efficiently which
positively affects performance of the company (Selarka, 2014). Therefore, previous studies
indicate that excess cash has positive effect on total factor productivity growth under good
governance and vice versa.
We have also considered the effect of corporate governance on firm performance
across different industries and ownership structures including competitive and concentrated
industries, family and non-family firms, and Shariah compliant and non-Shariah compliant
firms.
The fifth aspect of our study is to investigate the relationship between diversification
and value of cash holding, and the role of product market competition, family ownership,
and Shariah compliance in this relationship. Among the three forms of spending of excess
cash (i.e., capital expenditure, diversification, and dividend), diversification is the most
dominant source in Pakistan. Due to existence of family firms in Pakistan most of the firms
involve in corporate diversification for empire building for their family members. Therefore,
the present study is curious to investigate direct effect of corporate diversification on firm
value in the context of Pakistan.
Agency cost is involved when a firm involves in diversification. Under the lack of
proper governance mangers involve in diversification that benefit them instead of
shareholders due to agency problem. Mangers get benefit from diversification in several
ways. First, the un-diversifiable employment risk of manger minimizes due to
diversification (Amihud & Lev, 1981). Second, corporate diversification increases the size
of the firm, which leads to the increase in the control of managers (Jensen, 1986). Third,
16
corporate diversification makes manager of firm indispensable (Shliefer & Vishney, 1989).
Keeping in view these benefits managers of firm involve in diversification though it can cost
shareholders and destroy value of firm.
Economists have extensively discussed corporate diversification and its effect on
value of firm. Lang and Stulz (1994); Berger and Ofek (1995) argue that diversification
reduces value of firm due to agency problem. Similarly, Denis, Denis, and Sarin (1997) also
found that corporate diversification reduces overall value of firm due to agency problem
between managers and owners. Moreover, corporate diversification also involved cross-
subsidizing in which managers allocate funds to low growth opportunity projects from high
growth opportunity projects which destroy overall value of firm (Shin & Stulz, 1998; Rajan,
Sarveas, & Zingales, 2000). These results are in line with Jensen (1986) who argues that
managers involve in diversification for their personal benefits.
Diversified firms have severe agency problem compared to stand alone firms (Rajan
et al., 2000). Therefore, proper corporate governance is needed in diversified firm to
increase the value of firm. Diversification increases value of cash holding in good governed
firms (Tong, 2011) and vice versa. However, a very limited literature is available on the
effect of corporate diversification on value of cash holding. The previous researches that are
conducted on effect of diversification on firm value, measured firm value through Tobin Q
(e.g., Lins & Serveas. 2002). This research measures firm value through change in cash
following Faulkender and Wang (2006) and Dittmar & Mahrt-Smith (2007).
This study also investigated effect of corporate diversification on value of cash
holding in family firms. Family firms due to agency problem involve in empire building and
goes towards diversification (Jensen, 1986). Moreover, in emerging economies corporate
diversification discount firm value due to agency problem and low investor protection (Lins
17
& Servaes, 2002). Agency cost is the main cost involved in family firms when they go
towards diversification for their own benefit and destroys overall value of firm. Family
controlled firms involve in diversification to create empire for their successors on the cost of
minority shareholders. Consequently, diversification decreases value of cash holding in
family firms.
Finally, this research investigates whether diversification has significant effect on the
value of cash holding in Shariah compliant firms because Shariah compliance is an
alternative to corporate governance due to the underlying structure of the firms. Moreover,
Shariah compliant firms are constrained to diversify in sectors which are prohibited in
Islam.
1.2 Gap Identification
Firm level of cash holding has got attention from both practitioners and
academicians in the recent era. The probes are concentrated around the linkage between
corporate governance and different facets of cash holding. However, the extant literature is
limited in several ways:
First, the relationship of corporate governance and level of cash holding and value of
cash holding is considered in developed economies (e.g., Harford et al., 2008; Dittmar &
Mahrt-Smith, 2007; Pinkowitz et al., 2006; Kalcheva and Lins, 2007; Kuan et al., 2011; Al-
Najjar & Clark, 2017; Seifert & Gonenc, 2018; Liu & Yuan, 2018). Harford et al. (2008)
suggests that future research should be conducted on relationship of corporate governance
and cash holding in other economies where corporate governance structure and situation is
different. Liu and Yuan (2018) conducted research on U.S non-financial market and found
that corporate governance effect cash holding in financial constraint firms. The future
direction they recommended that effect of corporate governance on cash holding is
18
investigated in other settings beside financial constraints (e.g., product market competition,
Family firms, and Shariah compliance). Similarly, Kuan et al. (2011) provides future
direction to conduct research in countries where family structure and setting of corporate
governance is different. On the other hand, Kalcheva and Lins (2007) recommended that
future research should be conducted on other related factors in addition of agency problem
(e.g., product market competition and Shariah compliance).
Keeping in view these recommendations, this dissertation seeks answer to the
unanswered question i.e., whether effect of corporate governance on cash holding and value
of cash holding vary across different industries and ownership structures. It includes
competitive and concentrated industries, family and non-family firms, and Shariah
compliant and non-Shariah compliant firms in a developing country i.e., Pakistan. Product
market competition acts as an external market discipline to mitigate agency problem and
need to check that whether product market competition has substitution effect or
complementary effect for corporate governance in Pakistan. Because, competition is
comparatively lower in Pakistani industries compared to developed economies because a
limited number of non-financial companies are registered on Pakistan stock exchange.
However, the effect of corporate governance on level of cash holding and value of cash
holding in competitive and concentrated industries is ignored in developing countries
particularly Pakistan, while very limited literature is available in developed countries (e.g.
Jain et al., 2013; Amman et al., 2013).
Similarly, the effect of corporate governance on cash holding in family firms is
investigated in developed economies (e.g. Kuan et al., 2011). In the same way, liu, Luo and
Tian (2015) investigated effect of family control on cash holding but does not consider
direct effect of corporate governance on cash holding in family and non-family firms.
However, the effect of corporate governance on value of cash holding in family firms is
19
ignored in extent literature particularly in the context of Pakistan. The agency problems of
family firms are quietly different as compared to non-family firms because in family firms
the conflict of controlling shareholders and minority shareholders is high compared to the
conflict between mangers and shareholders.
Moreover, Shariah compliant firms have low agency problems compared to non-
Shariah compliant firms and theoretically Shariah compliant firms act as substitute for
corporate governance. Shariah compliant firms portray an important sector in Pakistan.
Pakistan gives 2% tax rebate to Shariah compliant firms to avoid interest based financing
and promote Shariah compliance (Sheikh, 2016). However, the effect of corporate
governance on level of cash holding and value of cash holding in Shariah compliant firms is
ignored in the literature. Guizani (2017) recommended that due to difference of
characteristics between Shariah and non-Shariah compliant firms, future research should
conduct on the effect of corporate governance on cash holding in Shariah compliant firms.
Hayat and Hassan (2017) investigated whether corporate governance differ in Shariah and
non-Shariah compliant firms but they did not investigate the effect of corporate governance
on cash holding and value of cash holding in Shariah and non-Shariah compliant firms.
Second, Masood and Shah (2014) conducted research on corporate governance and
cash holding in Pakistan but they did not use corporate governance index. Moreover, they
recommend that besides agency problem other aspects should also be investigated.
Therefore, the present study uses corporate governance index as a proxy for corporate
governance. Moreover, as discussed earlier three new aspects including competition,
Shariah compliance, and family ownership are also considered in the relationship of
corporate governance and cash holding.
20
Third, the literature on effect of corporate governance on value of cash holding is
very limited. Moreover, the research efforts are concentrated in developed countries (e.g.
Dittmar & Mahrt-Smith, 2007; Jain et al., 2013; Uddin, 2016; Liu & Yuan, 2018). The
future direction recommended by (Liu & Yuan, 2018) is that other factors are considered
besides corporate governance and financial constraints, while determining marginal value of
cash holding. This study considers external market discipline, family ownership and Shariah
compliance, while investigating the effect of corporate governance on marginal value of
cash holding. However, in Pakistan the effect of corporate governance on firm value through
cash i.e., value of cash holding is an academic covert. Similarly, the previous researches on
effect of corporate governance and firm value used Tobin Q for firm value (e.g. Kalcheva &
Lins, 2007; Amman et al., 2011; Ararat, Black, & Yortoglu, 2017). However, the firm value
through the concept of value of cash holding (as suggested by Faulkender & Wang, 2006) is
a better approach than the Tobin Q because cash is easily expropriated by insiders as
compare to other type of assets for their personal benefits. Therefore, the present research
used the concept of value of cash holding (following the work of Faulkender & Wang,
2006) that is change in firm value through cash.
Fourth, corporate governance increases value of firm through efficient utilization of
excess cash. However, the research efforts in this regard are limited. Though, limited
research has been conducted on effect of corporate governance on utilization of excess cash
in U.S.A or using international data (e.g. Harford et al., 2008; Amman et al., 2011; Jain et
al., 2013). However, the effect of corporate governance on utilization of excess cash in
Pakistan is relatively overlooked. Similarly, the role of corporate governance on spending of
excess cash in competitive and concentrated industries, family and non-family firms and
Shariah and non-Shariah compliant firms is also ignored in extent literature.
21
Fifth, excess cash under good governance increases future performance of the
company that is characterized by efficient utilization of excess cash. Zabri, Ahmad and Wah
(2016) investigated effect of corporate governance on firm performance and future direction
of their study is that external mechanism is used to find out effect on firm performance. This
study fills the gap and used both internal governance and external market discipline and
investigated its effect on firm performance. However, there is limited research available in
developed economies that investigated relationship of excess cash under good governance
with the performance of a company (e.g., Dittmar & Mahrt-Smith, 2007; Harford et al.,
2008; Jain et al., 2013). The previous researches used operating profit as a proxy of firm
performance. This dissertation took the proxy of total factor productivity growth instead of
operating profit because operating profit can be manipulated by firm (Tian & Twite, 2011).
Total factor productivity growth shows the relation of outputs and inputs of firm is more
appropriate approach instead of single operating ratio. However, the effect of corporate
governance on excess cash and total factor productivity growth relationship is ignored in
extent finance literature. Moreover, previous researches is also silent about effect of
corporate governance on excess cash and total factor productivity growth relationship in
competitive and concentrated industries, family and non-family owned firms, Shariah and
non-Shariah compliant firms.
Finally, corporate diversification is important way of disgorging excess cash as
compared to other ways of disgorging excess cash in Pakistan. The research on effect of
corporate diversification on value of cash holding in good governance firms and poor
governance firms is conducted in developed country (e.g. Tong, 2011). However, the effect
of corporate diversification on value of cash holding is ignored in Pakistan. Espinosa, Jara
Maquieira, and Vieto (2018) conducted research on the relationship of diversification and
firm value and they suggested that in future, research should conduct on the channels
22
through which diversification effect on firm value. This study fill the gap to investigate
effect of corporate diversification on value of cash holding in good governed firm and poor
governed firm, competitive and concentrated industries, family and non-family firms,
Shariah and non-Shariah compliant firms. Tong (2011) investigated the relationship of
diversification and value of cash holding in good governance firms and low governance
firms. However, he did not consider product market competition, family ownership, and
Shariah compliance.
1.2 Problem statement
Cash is the asset which can easily be used by managers and controlling shareholders
for their personal interest and ultimately reduces value of firm. Therefore, proper
governance is needed to stop managers from expropriation. This dissertation empirically
investigates the effect of corporate governance on level of cash holding and value of cash
holding in Pakistan. In Pakistan, the level of corporate cash has increased due to high
earning of companies. In FY 2014-15, blue chips companies in Pakistan had earned
PKR286 billion in terms of cumulative profit after tax (Hussain, 2014). Due to lack of
proper governance this excessive cash is expected to be destroyed by mangers.
Forbes companies in the developed countries cutoff dividend and exercise institution
layoff in the wake of improving their operating statements and internal liquidity. However,
they consequently end up with large reserves of cash but limited investment opportunities.
“Cash creates problems because holding excessive cash is often just as bad as holding
excessive debt” (Picard, 2011). World third giant companies are holding $2.8 trillion cash in
gross terms and worry how to invest this extra cash.
Previous studies have witnessed mixed results for relationship of corporate
governance and cash holding. Harford et al. (1999) found insignificant effect on cash
23
holding. Dittmar et al. (2003); Kusnadi (2011); Amman et al. (2013); Liu and Yuan (2018)
investigated effect of corporate governance on cash holding and found negative relationship
of corporate governance and cash holding. On the other hand, Harford et al. (2008) found
positive effect of corporate governance on cash holding. “The inconclusive result of
corporate governance and cash holding raise question that whether the effect of corporate
governance on level of cash holding and value of cash holding vary across different
industries and ownership structures.” Therefore, dissertation investigates the effect of
corporate governance on cash holding and value of cash holding in variant contexts
including competitive industries, family firms, and Shariah compliant firms.
. Product market competition may have two effects for corporate governance
including the substitution and complementary effect in relationship with cash holding and
value of cash holding. The existing research addresses this problem that either competition
plays substitution effect or complementary effect for corporate governance in Pakistan
because competition is not very intense. “Businesses hate competition because it limits their
power to manipulate the market, forces them to invest in quality and cuts into their profits”
(Jamal, 2016). However, the corporate sector of Pakistan is characterized by low
competition. Therefore, considering competition in the relationship of corporate governance
with cash holding and value of cash holding respectively would provide important insights.
Similarly, family ownership can also significantly affect the relationship of corporate
governance with cash holding and value of cash holding. The majority of research on family
firms is conducted in the context of developed countries while developing countries are
relatively ignored. Pakistan is not an exception though family firms are dominant in
Pakistan since its independence in 1947. Moreover, Pakistan is an emerging economy
therefore the structure and behavior of family firms is quite different than the developed
countries and therefore, this area needs further insights.
24
Similarly, it is also important to investigate the effect corporate governance on level
and value of cash holding in Shariah compliant firms. “Shariah compliance is gaining
attention among the academicians because Shariah compliance is substitute to the
governance. Theoretically, Shariah compliance is substitute for good governance.
Therefore, this research empirically investigates the effect of corporate governance on level
of cash holding and value of cash holding respectively in Shariah compliant and non-
Shariah compliant firms”.
Corporate governance increases value of firm through efficient utilization of excess
cash. However, the research efforts in this regard are limited. Though, research has been
conducted on effect of corporate governance on utilization of excess cash in U.S.A or using
international data (e.g. Harford et al., 2008; Amman et al., 2011; Jain et al., 2013).
“However, the effect of corporate governance on utilization of excess cash in Pakistan is
relatively overlooked. Similarly, the role of corporate governance on spending of excess
cash in competitive and concentrated industries, family and non-family firms and Shariah
and non-Shariah compliant firms is also ignored in extent literature”. This research
empirically investigates whether good governance promote efficient utilization of excess
cash which leads to increase in firm value.
Moreover, the efficient utilization of excess cash due to good governance
consequently improves firm performance. However, the research efforts in this context are
limited in Pakistan. Therefore, this research investigates the effect of excess cash under
good governance on firm performance in the context of Pakistan. Whether, this relationship
varies across different setting including competitive and concentrated industries; family and
non-family firms and Shariah and non-Shariah compliant firms. However, previous
researches e.g., Dittmar and Mahrt-Smith (2007); Harford et al. (2008); Jain et al. (2013)
used operating profit, while linking excess cash with performance under good and poor
25
governance. Present study besides traditional accounting ratios considers total factor
productivity growth for performance because total factor productivity growth is a stronger
proxy for performance measurement than the operating profit ratio (Tian & Twite 2011).
Similarly, corporate diversification is a major academic issue in both developed and
underdeveloped economies and firms in Pakistan spend excess cash on corporate
diversification. Research shows that diversification decreases value of firm due to agency
problem and Pakistani firms actively engage in corporate diversification. “However, the
effect of corporate diversification on value of cash holding is ignored in Pakistan though
Pakistani firms actively engage in corporate diversification”. Therefore, this research
considers the effect of corporate diversification on value of firm. Moreover, this relationship
is also considered in the context of competitive and concentrated industries, family and non-
family firms, Shariah and non-Shariah compliant firms.
1.4 Objectives of the study
Keeping in view the research gaps the following objectives and sub objectives have been set
for the present dissertation:
1. To investigate effect of corporate governance on cash holding
1(a): To examine the role of product market competition on corporate governance and cash
holding relationship
1(b): To examine the role of family ownership on corporate governance and cash holding
relationship
1(c): To investigate the role of Shariah compliance on corporate governance and cash
holding relationship
2. To investigate the effect of corporate governance on value of cash holding
2(a): To investigate the effect of corporate governance on cash holding in competitive and
concentrated industries
26
2(b): To examine the effect of corporate governance on value of cash holding in family and
non-family firms
2(c): To investigate effect of corporate governance on value of cash holding in Shariah and
non- Shariah compliant firms
3. To investigate the role of good governance on spending of excess cash
3(a): To examine the role of good governance on spending of excess cash in competitive and
concentrated industries
3(b): To examine role of good governance on spending of excess cash in family and non-
family firms
3(c): To examine role of good governance on spending of excess cash in Shariah and non-
Shariah compliant firms.
4. To investigate role of good governance on relationship between excess cash and total
factor productivity growth
4(a): To investigate role of good governance on relationship between excess cash and total
factor productivity growth in competitive and concentrated industries
4(b): To examine role of good governance on relationship of excess cash and total factor
productivity growth in family and non-family firms
4(c): To examine role of good governance on relationship of excess cash and total factor
productivity growth in Shariah and non- Shariah compliant firms
5. To examine effect of corporate diversification on value of cash holding
5(a): To examine whether corporate governance increases value of cash holding in good
governance firms
5(b): To examine that whether corporate diversification increases value of cash holding in
competitive industries
5(c): To examine effect of corporate diversification on value of cash holding in family firms
5(d): To investigate effect of corporate diversification on value of cash holding in Shariah
and non- Shariah compliant firms.
27
1.5 Research Questions
1. (a) What is the effect of corporate governance on level of cash holding?
(b) What is the role of product market competition on corporate governance and cash
holding relationship?
(c) What is the effect of corporate governance on cash holding in family firms?
(d) What is the effect of corporate governance on cash holding in Shariah compliant firms?
2. (a) What is the effect of corporate governance on value of cash holding?
(b) What is the effect of corporate governance on value of cash holding in competitive and
concentrated industries?
(c) What is the effect of corporate governance on value of cash holding in family and non-
family firms?
(d) What is the effect of corporate governance on value of cash holding in Shariah and non-
Shariah compliant firms?
3. (a) What is the role of corporate governance on utilization of excess cash?
(b) What is the role of corporate governance on utilization of excess cash in competitive and
concentrated industries?
(c) What is the role of corporate governance on utilization of excess cash in family and non-
family firms?
(d) What is the role of corporate governance on utilization of excess cash in Shariah and
non- Shariah compliant firms?
4. (a) What is the role of corporate governance on effect of excess cash and total factor
productivity growth?
(b) What is the role of corporate governance on effect of excess cash on total factor
productivity growth in family and non-family firms?
(c) What is the role of corporate governance on effect of excess cash on total factor
productivity growth in Shariah and non-Shariah compliant firms?
5. (a) What is the effect of diversification on value of cash holding?
(b) Does diversification increase value of cash holding in good governance firms?.
(c) What is the effect of corporate diversification on value of cash holding in competitive
and concentrated industries?
28
(c) What is the effect of diversification on value of cash holding in family and non-family
firms?
(d) What is the effect of diversification on value of cash holding in Shariah and non-Shariah
compliant firms?
1.6 Significance of the Study
This study is important in several ways. For example:
First, cash is an important area for both academicians and practitioners in recent era.
Pakistani blue chips companies hold large amount of cash and worry about its spending
(Hussain, 2014). Researchers like Dittmar and Mahrt-Smith (2007); Harford et al., (2008)
shows that due to agency problem cash is destroyed by mangers for their own interest which
ultimately destroys value of firm. Therefore, this study will help academicians and
practitioners to conceptualize the effect of corporate governance on cash holding and value
of cash holding.
Second, corporate governance has got attention from academicians and policy
makers after the crises of Enron; Worldcom and Taj company scandal in Pakistan etc.
Recently the scandal of United Breweries in India is classic example of how bad corporate
governance destroys value of firm and leads big losses for their shareholders. This research
contributes to the existing literature by investigating the role of corporate governance in
cash holding and value of cash holding and how this relationship varies across different
settings. It includes competitive and concentrated industries; family and non-family firms,
Shariah and non-Shariah compliance firms.
Third, this research will provide interesting implications for policy makers and
academia regarding the role played by competition (i.e., being substitute or complementary)
in the relationship of corporate governance and cash holding in Pakistan. Due to importance
29
of competition Government of Pakistan enforce “competition act, 2010” which give power
to competition commission of Pakistan to ensure free competition and discourage such types
of mergers and acquisition which creates monopoly in the market.
Fourth, family controlled firms are significant part of Pakistan economy (Yasser,
2011). The policies of family firms are quite different compared to non-family firms (Alim
& Khan, 2016). This research shows importance of corporate governance in family firms
and established the relationship of corporate governance with cash holding and value of cash
holding in family firms. Fifth, this research also shows the relationship of corporate
governance and cash holding and value of cash holding in Shariah compliant firms. As
research like (Hayat & Hassan, 2017) shows that Shariah compliance firms is alternative to
good governance and mitigate agency problem. Worldwide assets of Islamic industry have
reached from US$ 150 billion in 1990s to US$ 2.2 trillion in the recent years (Hayat &
Hassan, 2017). Moreover, it will touch in US$ 3 trillion in 2020 (“2017 to be the best year
for Islamic financial market”, 2017). This study will help practitioners and academia to
better understand the effect of corporate governance on level of cash and value of cash
holding in Shariah compliant firms.
Sixth, spending of excess cash is among the debatable issues in finance literature
(Dittmar & Mahrt-Smith, 2007; Harford et al., 2008). This study will help academia and
practitioners in understanding the role of corporate governance in utilization of excess cash
and how this role varies in different settings including competitive and concentrated
industries; family and non-family firms; Shariah and non-Shariah compliant firms.
Seventh, this study for the first time links excess cash with the total factor
productivity growth proxy of firm performance. Previous researches used operating profit
ratio while establishing link between excess cash and total factor productivity growth under
30
good governance. Total factor productivity is a better measure than the accounting ratio
(Bath et al., 2005; Tian & Twite, 2011). This study helps in conceptualizing the role of
excess cash in determining the total factor productivity growth under good governance.
Moreover, this research helps in conceptualizing that whether the effects of corporate
governance on excess cash and total factor productivity growth relationship in competitive
industries supports complementary argument.
Moreover this study provides insight about the role of corporate governance on
excess cash and total factor productivity growth in family firms, and Shariah compliant
firms
Finally, this study also has significance in terms of addressing the debate in finance
literature on corporate diversification. Previous researches (e.g., Lins & Serveas, 1999;
Espinosa et al., 2018) shows that diversification exert negative effect on firm value due to
agency problem. This study is important in terms of understanding whether diversification
reduces value of cash holding in developing economy like Pakistan due to agency problem.
Previous studies have considered developed economies while examining the relationship of
corporate diversification and value of cash holding (e.g., Tong, 2011). This study also has
significance for academia and practitioners to understand the effect of diversification on
value of cash holding in competitive and concentrated industries; family and non-family
firms; Shariah and non-Shariah compliance firms.
1.7 Significance in Pakistani context
Pakistan has rules and regulation for investor protection, however; there are
constraints in implementing and enforcing those laws and regulations. An article was
published in Dawn News in 2003 claimed that majority shares are held by the directors or
with people that directors use for proxy (“Minority shareholders to be empowered”, 2004).
31
It is very difficult for minority shareholders to achieve 10% voting right which is necessary
to raise voice to board.
Furthermore, shareholders' activism is very low in Pakistan due to dispersion in
minority shareholders. This makes advantageous for controlling shareholders to appoint
directors that work as a puppet for them (“Giving voice to minority shareholders”, 2012).
Moreover, most of the directors act as the independent directors on other boards that are
why they serve interests of each other. Therefore, for proper governance, SECP is
developing governance codes with the passage of time. The first step for corporate
governance is taken in 2002 while the latest codes are incorporated in 2012.
Similarly, the research efforts are also limited in the context of Pakistan. Studies on
cash holding and value of cash holding are concentrated in developed economies (e.g.,
Opler et al., 1999; Ditmar & Mahrt-Smith, 2007; Pinkowitz et al., 2006; Palazzo, 2012).
However, very little studies have been conducted in the context of Pakistan to investigate
the effect of corporate governance on cash holding and value of cash holding in particular.
Research shows that due imperfect capital market the worth of cash holding
increases. “Pakistan capital market is not developed due to lack of depth, lack of breadth
and crowding out effect” (Nazar & Sarfaraz, 2016). Pakistani market provides an ideal
context for studying cash holding and value of cash holding. Moreover, corporate
governance needs extensive research efforts in Pakistan because giant family firms exist that
tend to fulfill their own destiny at the cost of minority shareholders. Similarly, the corporate
sector of Pakistan is characterized by appointment of non-technical people on the key posts
of the board. Keeping in view these facts this study first time considers relationship between
corporate governance and value of cash holding in Pakistan.
32
Similarly, competition is important for the economic growth of the country and work
as external discipline on mangers. That is why competition commission of Pakistan has
given responsibility and authority to ensure healthy competition in Pakistan. Since, 2007 to
2015 competition commission of Pakistan levied 26 billion Pakistani rupees in the form of
penalty due to violation of competition law (“CCP imposed over RS 26 billion in 8 years,”
2015). Therefore, this study for the first time in Pakistan establishes the relationship of
corporate governance with level of cash holding and value of cash holding in competitive
and concentrated industries. Whether, external market discipline plays substitution or
complementary role for corporate governance in Pakistan.
In Pakistan family oriented firms is dominant since from independence because in
past majority of economy was ruled by 22 big families. Agency problem prevail in family
firms in the form of conflicts of interest between controlling shareholders and minority
shareholders. This study is pioneering in considering the relationship of corporate
governance with value of cash holding in family firms. Similarly, the Shariah compliant
industry is growing all over the world and Pakistan is no exception. This study is the first
attempt towards establishing the relationship of corporate governance with level of cash
holding, value of cash holding, and utilization of excess cash in Shariah compliant firms.
Moreover, studies related to diversification are majorly conducted in developed economies
(e.g., Subramaniam et al., 2011; Tong, 2011). Agency problem is one of the reasons for the
involvement of firms in corporate diversification. Therefore, this study will help the
practitioner in conceptualizing whether diversification with agency cost decrease value of
cash holding?
33
1.8 Contextual Contribution
The dissertation contributes to different aspects of corporate governance and cash
management both in the context of Pakistan and to existing literature.
First, very limited research is available on effect of corporate governance on value
of cash holding in the context of developed economies (e.g., Dittmar & Mahrt-Smith, 2007;
Jain et al., 2013; Uddin, 2016). Moreover, this area is ignored in the context of developing
countries. It for the first time checks the effect of corporate governance on value of cash
holding in Pakistan because there is a divergence in the corporate governance issues of
every economy particularly the developed and developing economies. Masood and Shah
(2014); Basheer (2014); Ullah and Kamal (2017) investigated effect of corporate
governance on cash holding in the context of Pakistan. This research contributed in the
context of Pakistan that it checked whether agency problem leads to high cash holding and
that high cash holding decrease firm value.
Second, it contributes to the literature by answering the research question whether
the effect of corporate governance on level of cash holding and value of cash holding is
different in different industries and ownership structures. For example, this study is the first
attempt to check the role of product market competition on the relationship of corporate
governance with level of cash holding and value of cash holding in Pakistan. The study
basically checks either product market competition is substitute or complement for corporate
governance in the relationship with level of cash holding and value of cash holding. There
is a divergence in the competitive structure of every economy particularly in the developed
and developing economy.
Similarly, family firms are dominant over the globe and Pakistan is not the
exception. The structure of family firms and their governance issues are quite different from
34
non-family firms. The other contribution of this dissertation to the extent literature is that it
also checks the effect of corporate governance on value of cash holding in family firms and
non-family firms in Pakistan. Sheikh and Khan (2015); Alim and khan (2016) investigated
effect of corporate governance on cash holding in family firms in the context of Pakistan.
This research has contribution in the context of Pakistan that it investigated whether
corporate governance increase value of cash holding in family firms.
Shariah compliance is hot debatable issue in corporate finance because Shariah
compliance firms performed better in crises period compare to non-Shariah compliant firms.
The research made valuable addition to the extant literature by answering whether corporate
governance has different effect on level and value of cash holding in Shariah and non-
Shariah compliant firms in context of Pakistan. This dissertation for the first time
investigated substitution role of Shariah compliance for corporate governance in
relationship with cash holding and value of cash holding. Shariah compliant firms are
growing in Pakistan.
Third, the previous research (e.g., Dittmar & Mahrt-Smith, 2007; Jain et al., 2013)
claimed that corporate governance increases value of cash holding through efficient
utilization of excess cash. This research contributes to the extant literature by checking the
effect of corporate governance on utilization of excess cash in Pakistan and whether product
market competition, family ownership and Shariah compliance has role on the relationship
of corporate governance and utilization of excess cash.
Fourth, the previous researches (e.g. Dittmar & Mahrt-Smith, 2007; Jain et al., 2013)
indicate that corporate governance increases future performance of the company due to
efficient utilization of excess cash. The previous researches used operating profitability for
the performance measurement. This dissertation is pioneering in terms of using total factor
35
productivity growth as a proxy of firm performance to check the relationship of excess cash
with firm performance. Total factor productivity growth is superior measure as compare to
operating profit because single accounting ratio has a higher chance of manipulation (Tian
& Twite, 2011).
Finally, this dissertation also enriched research by investigating the effect of
corporate diversification on value of cash holding in Pakistan. The reason is that corporate
diversification is the most dominant form of spending excess cash in the context of Pakistan
among the three way of disgorging excess cash (i.e., industry adjusted change in capital
expenditure, dividend and diversification). Family firms are dominant in Pakistan and
family firms involve in diversification due to family altruism. Similarly, the dissertation is
also pioneering in terms of investigating the effect of corporate diversification on value of
cash holding in good governance and poor governance in the context of Pakistan. Moreover,
the research contributes to extant literature by considering the role of product market
competition, family ownership, and Shariah compliance in the relationship of corporate
diversification and value of cash holding.
1.9 Theoretical contribution
This study is not going to generate new theory. This study follows deductive
approach for theory testing. This research is based on the agency theory (Jensen, 1986)
which is tested in different scenarios. Beside agency theory, precautionary theory (Keynes,
1936) and other theoretical hypotheses i.e., substitution and complementary hypotheses are
also applied. This research basically enriches agency theory through investigating the effect
of corporate governance on cash holding and value of cash holding. Furthermore, to check
the substitution or complementary effect of external market discipline and Shariah
compliant firms are also considered. Substitution effect argument claims that external
36
market discipline is enough to mitigate agency problem despite of firm level poor
governance (Holmstrom, 1982; Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller,
2010, 2011; Guadalupe & Perez-Gonzalez, 2010; Amman et al., 2013). On the contrary,
complementary effect argument claims that reducing agency problem external market
discipline needs efficient firm level governance (Koke & Renneboog, 2005; Jain et al.,
2013).
This research also enriches agency theory and shows the relationship of corporate
governance with cash holding and value of cash holding respectively in family firms.
Family firms have another type of agency problem that is between controlling shareholders
and minority shareholders which arise particularly when the founder or a family member is
appointed on post of CEO or Chairman (Shliefer & Vishney, 1997; Villalonga & Amit,
2006; Villalonga et al., 2015). Moreover, this research also explains the relationship of
corporate governance through three different hypothesis including flexibility hypothesis,
spending hypothesis and shareholder power hypothesis.
Flexibility hypothesis claims that entrenched mangers want to free themselves from
external monitoring and hold high cash (Jensen, 1986). Spending hypothesis explains that
entrenched mangers spend cash rapidly and therefore corporate governance has positive
relationship with cash holding. On the other hand, shareholder power hypothesis posit that
shareholders have confidence on mangers to hold cash in the presence of good governance
(Harford et al., 2008). Therefore, corporate governance has positive relationship with cash
holding according to shareholder power hypothesis.
37
1.10 Delimitation of Research
The current study focused effect of corporate governance on different facets of cash
because cash is easily destroyed by managers and controlling shareholders. The current
study focused only non-financial companies and excluded financial sector from sample
because the structure and cash holding behavior is quietly different in financial and non-
financial companies. The study focused Pakistan because the corporate governance issues
and setting is quietly different in developed and developing economies. Furthermore, agency
problem is high in Pakistani companies due to lack of law enforcement and dominancy of
family oriented firms.
The study only emphasizes those attributes of corporate governance which is
common and agreed governance variables in almost all studies. The common variables of
governance provide us generalizable result on the behavior of corporate governance in
competitive and concentrated industries, family and non-family firms, Shariah and non-
Shariah compliant firms. The study only used corporate governance index instead of
individual corporate governance variables in the analysis. This is because index is easy to
interpret and give clear effect for effect of corporate governance on different facets of cash
management in different industries and ownership structures.
1.11 Organization of Study
The first chapter covers introduction of study, second chapter covers literature
review, third chapter covers research methodology, fourth chapter includes result and
discussion and fifth and final chapter covers conclusion of the study.
38
CHAPTER 2
LITERATURE REVIEW
The second chapter of dissertation covers literature review. It includes literature on
the effect of corporate governance on level of cash holding, value of cash holding,
utilization of excess cash and performance of firm. This chapter also covers literature on
role of product market competition, family ownership and Shariah compliance in the
relationship of corporate governance and cash holding. Moreover, the literature on effect of
corporate diversification on value of cash holding is also presented.
2.1 Corporate governance and Cash holding
Cash holding is one of the important decisions for firm managers. In case of perfect
capital market the worth of cash is negligible because firm can raise finances easily and with
zero cost through capital market (Opler et al., 1999). This is not the case in real world
because generation of cash to finance firms operation bears some cost. The determinants of
cash holding were properly discussed by Opler et al., (1999) under a framework of trade off
model and financial hierarchy theory.
According to the tradeoff model firms hold extra cash however; it negatively affects
shareholder wealth if the cost of holding cash is greater than return of holding cash. There
are two motive for holding cash including precautionary motive and transaction motive.
According to precautionary motive firms hold cash to prevent themselves from crises and
external shock (Keynes, 1936). In crises period those firms have better survival chances that
have sufficient amount of cash because in crises period firms face difficulty in generating
funds through capital markets (Opler et al., 1999). According to transaction motive, holding
cash by firm is beneficial in the sense to save transaction cost incurred on generation of
39
external financing or cash also mitigate the need for liquidation of assets for payment of
debts (Opler et al., 1999).
On the other hand, the financial hierarchy theory claims that cash and debt has no
optimal level and cash hoarding by company is explained in the context of investment and
as discussed by pecking order theory for financial decisions. Firm’s cheap source of finance
is internal fund and the costly source of financing is equity financing and this is one of the
reason that firms prefer internal liquidity. Variables used in explaining tradeoff model and
hierarchy theory are almost same but their predictive signs are different. According to
tradeoff model capital expenditure has positive relationship with level of cash, while it has
negative sign with level of cash in case of hierarchy theory. In the same way hierarchy
theory consider leverage is substitute of cash and it has negative relationship with cash
(Dittmar et al., 2003). Guizani (2017) investigated determinants of cash holding in
petrochemical and non-petrochemical industries and the result posits that determinants of
cash holding posits significant different effect on cash holding in both industries.
As, the level of cash normally increases with firms due to economic expansion,
mangers of the firms have to decide either the excess cash should be accumulated, or it
should be spent on capital expenditure (i.e., internal investment) or acquisition or should be
disbursed among shareholders (Harford et al., 2008). However, if shareholder wealth
maximization is ignored managers and controlling shareholders expropriate cash for their
personal benefit due to agency problem. The utilization of internal funds is main problem
between mangers and shareholders (Jensen, 1986). Proper corporate governance is needed to
mitigate agency problem between mangers and shareholders. Corporate governance is set of
rules and regulation to conduct business. La Porta, Lopez-DE-Silances, Shilfer, & Vishney
(2000) make definition that “Corporate governance is, to a certain extent, a set of
40
mechanisms through which outside investors protect themselves against expropriation by
the insiders.” They associated “insiders” to both managers and controlling shareholders.
Moreover, corporate governance is a system through which firms control and
monitor the interaction among stakeholders. Another definition on corporate governance
gave by Omran (2004) that “Corporate governance comprises the private and public
institutions (both formal and informal) which together govern the relationship between
those who manage corporations and those who invest resources in corporations. These
institutions typically include a country’s corporate laws, securities regulations, stock-
market listing requirements, accepted business practices and prevailing business ethics”.
The consequences of poor governance may arise in form of business failure. Enron, Lehmon
Brothers, WorldCom and Taj Company Ltd are few examples of business failures caused by
the exploitation of minority shareholders wealth by entrenched mangers and controlling
shareholders. The discussion and study about the effectiveness of corporate governance
address this issue that how entrenched managers’ decision can be brought in line with the
wealth maximization of shareholders.
Agency theory claim that self-interested managers use cash for their own benefit
instead of serving benefit of shareholders. If firm level governance is efficient, minority
interest is protected from exploitation of entrenched managers and controlling shareholders
(Papaioannou, Strock, & Travalos, 1992; Myers & Rajan, 1998; Chen & Chuang, 2009).
Managers and controlling shareholders destroy cash for their own benefit under poor
corporate governance on the cost of minority shareholders (Dyck & Zingales, 2004;
Nenova, 2003). Dittmar and Mahrt-Smith (2007) suggest that cash holding by firms has
increased significantly in the recent years; moreover cash is the important determinant of
overall value of firm. However, firm level governance is changing slowly overtime in
comparison with the high variation in the firm level cash. Therefore, powerful test is
41
demanded to investigate effect of corporate governance on cash holding (Dittmar & Mahrt-
Smith, 2007). The relationship of corporate governance on cash holding is supported by
three hypothesis, which are summarized by Harford et al. (2008) that is 1) flexibility
hypothesis2) spending hypothesis 3) shareholder power hypothesis.
According to the flexibility hypothesis entrenched managers hold high cash because
these managers want to free themselves from outside monitoring (Jensen, 1986) and
shareholders are unable to force managers for low level of cash holding. So, corporate
governance has negative relationship with cash holding. Spending hypothesis claims that in
firms with high agency problem, managers disburse cash in negative NPV projects for their
own benefits that destroy value of firm. So, corporate governance according to spending
hypothesis posits positive relationship with cash holding. Share holder power hypothesis
than claim that minority shareholders have power to exert pressure on managers to work
efficiently. In this case minority shareholders willingly allow mangers for holding high cash
to prevent them from under investment and protect from bankruptcy. Jensen and Meckling
(1976); Myers and Majluf (1984) investigated agency cost in context of information
asymmetry for generating funds from capital market due to information asymmetry exist
between providers of capital and managers. Shareholders should make decision that how
much cash mangers hold to avoid underinvestment problem. In, context of shareholder
power hypothesis corporate governance shows positive relationship with cash holding.
However, empirical literature shows mixed result between corporate governance and
cash holding. Harford et al. (1999) posits that corporate governance has insignificant effect
on level of cash holding. Kalcheva and Lins (2007) used international data and found that
corporate governance has insignificant relationship with level of cash holding. Harford et al.
(2008) conducted research in U.S.A and found positive relationship of corporate governance
and cash holding their result is supported by spending hypothesis. In same way, Liu and
42
Yuan (2018) shows that firm level of corporate governance and financial constraints shows
negative relationship with level of cash holding. Their result further posits that financial
constraint firms with good governance hold less cash. Dittmar et al. (2003) also conducted
research on international data and found that those countries where investors are less
protected hold high level of cash and countries where investors are highly protected hold
less cash. Shareholders pressurize management of company in countries where investor
protection is high to efficiently utilize excess cash especially in form of dividend to the
shareholders. Kusnadi (2011) also investigated effect of corporate governance on cash
holding in family firms and found that high agency problem leads to high level of cash and
lower agency problem leads to low level of cash. Amman et al. (2013) conducted research
on European economies and found negative relationship of corporate governance with level
of cash holding and their result is supported by flexibility hypotheses.
Al-Najar and Clark (2017) conducted research on MENA countries and consider
internal and external governance variables and found that board size has negative
relationship with cash holding. Moreover, firms hold less cash in those economies where
bank has high and strict supervision and international security law standards are followed.
Overall their result shows negative relationship of corporate governance with level of cash
holding. Seifert and Gonenc (2018) conducted a research on international data and
investigated the effect of both country and firm level governance on level of cash holding.
Their result posits that governance of both country and firm level shows negative
relationship with cash holding. Furthermore, Lee and Lee (2009) investigated effect of
corporate governance attributes on level of cash holding and found that firms whose board
size and managerial entrenchment is low hold less cash. Furthermore, independent directors
on board also show negative relationship with cash holding. Roy (2018) conducted research
in India and found that corporate governance has negative effect on corporate cash holding.
43
The result support flexibility hypothesis that posits that governance has negative
relationship with cash holding. Another study conducted by Amman et al. (2013) found that
firm level governance shows negative relationship with level of cash holding. Furthermore,
their study shows that firms under good governance spend less excess cash on internal
investment.
Similarly, the studies that are conducted in Pakistan e.g., Basheer, (2014)
investigated effect of corporate governance variables on cash holding. He found that board
independence has positive effect on level of cash holding, whereas CEO duality and family
dummy shows negative and insignificant effect on level of cash holding. Moreover,
managerial ownership shows nonlinear relationship with level of cash holding. Similarly,
Ullah and Kamal (2017) conducted research to investigate effect of board characteristics on
cash holding and found that corporate governance has negative relationship with cash
holding. In the same way, Masood and Shah (2014) conducted research in Pakistan context
and found board size and proportion of non-executive directors on board shows negative
relationship with level of cash holding and ownership variables shows positive relationship
with cash holding. So, on the basis of above discussion corporate governance and cash
holding has inconclusive results and deduce the following hypothesis.
H1a: Corporate governance has significant effect on level of cash holding
An important question is raised by recent studies that whether effect of corporate
governance on cash holding vary for all industries and all categories of companies. Ullah
and Kamal (2017) found effect of corporate governance on cash holding in big size and
small size firms and dictator and democratic regime. This dissertation investigated effect of
corporate governance on cash holding in competitive industries and concentrated industries;
family and non-family firms and Shariah compliant and non-Shariah compliant firms.
44
2.1.1 Corporate governance, Product market competition and cash holding
This section focuses the role of product market competition on corporate governance
and cash holding relationship. The argument made by theoretical studies present that cash
has advantage for the firms existing in competitive industries. “Deep pockets argument”
develops by Bolton and Scharfstein (1990) on the work of Telser (1966) argues that firms
will compete to their rivals on the basis of internal funds. Therefore, those firms will
successfully survive in product market whose internal cash is available for innovation
because pecking order theory suggests that internal funds are the cheapest and easiest
available source of financing.
Furthermore, cash provide competitive edge to the companies in competitive
environment and enable them to defend themselves from “predatory” actions from their
rivals and discourage new entrants in the market through aggressive actions (Bolton &
Scharfstein, 1990).
Haushalter et al. (2007) argue that firms facing under investment problem in product
market due to insufficient funds lose their market share in the market. Firms operating in
competitive industries raise funds through debt financing and competitors take advantage
from this situation and utilize their internal funds on investment (Chevalier, 1995;
Campello, 2003, 2006). Two hypotheses including the substitution and complementary
effect hypothesis explain the role of product market competition for corporate governance in
relationship with cash holding. Product market competition work as external market
discipline which force managers to work in the best interest of shareholders and increase
firm value despite of high agency problems (Amman et al., 2011; Alimov, 2014). Corporate
governance matters in the industries where external market discipline is weak and shows
substitution effect of product market competition to corporate governance and product
45
market competition work as substitute for corporate governance (e.g., Holmstrom, 1982;
Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller, 2010, 2011; Guadalupe & Perez-
Gonzalez, 2010; Amman et al., 2013). In contrast, Selarka (2014) found competitive effect
of product market competition and shows that external market discipline needs efficient firm
level governance to mitigate agency problem and support complementary effect of product
market competition to corporate governance. On the other hand, Karuna (2007) gave
different explanation of product market competition and corporate governance besides
substitution effect and complementary effect of product market competition. He explained
that basically financial decisions of competitive firms are in the best interest of shareholders
because corporate governance of those firms is good that operate in competitive industries
compared to the firms operating in concentrated industries. Moreover, in competitive
industries firms have more supremacy and require to be monitored. Jain et al. (2013) shows
the joint effect of corporate governance and product market competition on cash holding and
shows corporate governance significantly affects cash holding in competitive industries. So,
on the basis of above discussion this research generated its 2nd hypothesis as following
H1b: Product market competition work as substitute for corporate governance in
relationship with corporate cash holding.
H1b: Product market competition has complementary effect for corporate governance in
relationship with corporate cash holding.
2.1.2 Corporate governance, Family ownership and Corporate cash holding
In recent era family ownership attract attention from academicians and practitioners
due to their importance in terms of corporate decisions. Majority of research focused on
corporate governance and level of cash holding (See for example, Harford et al., 2008;
Dittmar & Mahrt-Smith, 2003; Chen & Chaung, 2009). Corporate governance is very
46
imperative for family firms because family members elect such type of dummy board that
serve the interest of particular family on cost of minority shareholders (Alim & Khan,
2016). However, the literature available on the role of family ownership between corporate
governance and cash holding is very limited and majority of work is done in developed
economies. The structure and role of family ownership is quite different in developing
countries compare to developed countries. The division of control and ownership in family
firms causes reduction in the conflicts of interest between managers and shareholders
(Anderson & Reeb, 2003; Claessens et al., 2000; Fama & Jensen, 1983; La Porta et al.,
1999; La Porta et al., 2000).
There are three perspectives regarding the role of family ownership. First, family
firms resolve agency problems particularly when founder work as CEO or Chairman of the
firm (Villalonga et al., 2015). Lapora et al. (1999) investigated the ownership structure of
the largest 20 companies in 27 economies and found that 69% family firms have CEO or
Chairman belonging to the family tree. Similarly, Claessen et al. (2000) claimed that in 57%
family firms in Asia CEO or Chairman are family members. Volpin (2002) found that in
Italy the key positions belong to particular family in 50% family firms. Villalonga and Amit
(2006) found that family members serve as CEO and Chairman among 66% family firms in
the sample of Fortune 500 family firms.
Secondly, agency conflict between controlling shareholders and minority
shareholders are higher in family firms (Villalonga et al., 2015). Moreover, family firms
engage in family altruism and want to pass business to their successors and expropriate cash
to fulfill firm legacy (Kuan et al., 2011). Similarly, Yeh et al. (2001) suggests that family
firms involve in policies that are fruitful for the controlling family and its family members.
47
Thirdly, the division between cash flow right and control right make controlling
shareholders able to expropriate the resources of firm (Kuan et al., 2011). The controlling
shareholders expropriate firm resources at the cost of minority shareholders. The problem of
agency becomes more severe when family business is inherited to second and third
generation. Research shows that only 15% family businesses continue to exist after third
generation, while the 85% family firms go astray after 3rd generation (Fudda, 2014). In
Pakistan 22 families were dominant in the recent past. However, only few have been able to
uphold their position due to agency problem that destroys overall value of firm.
Family firms involve in family altruism in passing their family businesses to the next
generation. Moreover, family members influence corporate decision of firm to adopt
policies that benefit family members on the cost of minority shareholders (Yeh, Lee, &
Woidtke, 2001). Family businesses make decisions to fulfill the needs and requirements of
particular family (Ward, 1987). Therefore, agency problem is high in family firms compare
to non- family firms. Alim and Khan (2016) shows that family firm’s cash holding is high
compare to non-family firms and lack of proper governance increases the chance of miss-
utilization of high cash for their own benefit. In the same way, Liu, Luo and Tian (2015)
shows that family firms in china hold high cash compare to non-family firms and utilize
cash for their own benefit instead of other shareholders. Kuan et al. (2011) shows that
family ownership causes agency problem when it exceeds a certain level and agency
problem is high between controlling shareholders of a family firm and minority shareholders
instead of between mangers and shareholders. Therefore, there is a need to investigate effect
of corporate governance on cash holding in family firms. For, this purpose the following
hypothesis is deduced.
H1c Corporate governance has significant effect on level of cash holding in family firms
48
2.1.3 Corporate governance, Shariah compliance and Cash holding
To check the effect of corporate governance on cash holding in the Shariah
compliant firms is one of the objectives of this dissertation. Islam permits and encourages
Halal business to bring wealth in circulation and break down vicious circle of poverty.
There is clear cut verse in Holy Quran about business “O ye, who belief! Fulfill obligations”
(Al-Maidah:1). “Allah Commands justice, the doing of good, and liberty to kith and kin, and
He forbids all shameful deeds, and injustice and rebellion” (Al-Nahl:90). Islam does not
prohibit profit making activities but on the basis of justice because profit making is the core
objective of any business (Hassan, 2008, Ali, Al-Aali & Al-Owaihan, 2013).
Islamic financial industry is growing rapidly due to increase in the size of Islamic
banks in Muslim majority countries as well as non-Muslim majority countries. Reuters
(2013) claimed that Shariah based financial industry touches 2.2 trillion US dollar.
Recently Islamic finance gained attraction from academicians (Hayat and Hassan, 2017).
During the era of crises Islamic index return beat conventional index return ((Ho et al.,
2014; Bhatt & Sultan, 2012; Jouaber-Snoussi et al., 2012). Baele et al. (2014) shows that
defaulted loan in Islamic banks is low compare to convention banks. In Muslim majority
countries Shariah base banking contribute to financial development (Gheeraert, 2014).
A very limited research has been done on Shariah based non-financial companies
particularly on the effect of corporate governance on cash holding in Shariah compliant
non-financial companies is ignored in extant literature. In Pakistan a company must meet the
following requirements to be included in the list of Shariah compliant firms
(www.meezanbank.com)
1. Debt to asset ratio has maximum limit of 37%
2. Non-compliant investments to total assets should be equal or less than 33%
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3. Non-compliant income to total revenue must be less than 5%
4. Illiquid assets to total assets maximum is 25%
5. Net Liquid Assets To Share Price liquid asset per share should be less than market price per
share
Shariah compliant firms have lower debt to asset ratio compared to the non- Shariah
compliant firms (Hayat & Hassan, 2017). Leverage force managers to work efficiently and
spend corporate resources in best interest of shareholders (Grossman & Hart, 1982; Jensen,
1986). Good corporate governance substitutes leverage because it reduce agency problem
that arise due to conflict between managers and shareholders (Arping & Sautner, 2010;
Jiraporn et al., 2012). Lower levered companies are good governed and Shariah compliant
firms have lower debt as compared to non-Shariah compliant firms (Hayat & Hassan,
2017). On the basis of above argument this research can conclude that Islamic labeled firms
are substitute to good governance.
H1d: Shariah compliance has substitution effect for corporate governance in relationship
with corporate cash holding
Keeping in view the discussion in the proceeding sections (2.1.1 to 2.1.4) a question
arises that whether agency problem leads to high cash and high cash leads to decrease firm
value. The question arise that what is the effect of corporate governance on value of cash
holding? Moreover, how does the effect of corporate governance on value of cash holding
varies across the competitive and concentrated industries; family and non-family firms;
Shariah and non-Shariah compliant firms?.
2.2 Corporate governance and value of cash holding
In the presence of theoretical arguments, empirical research on cash holding and
corporate governance is inconclusive on the fact that whether poor governance leads firms
50
towards high level of cash holding. Whether high cash holding with poor corporate
governance decreases firm value (Kalcheva & Lins, 2007). As, per agency theories,
entrenched managers misuse firm resources for their own interest at the cost of minority
shareholders and reduces the value of firm (Jensen, 1986; Dittmar & Smith, 2007; Harford
et al., 2008; Jain et al., 2013). The appropriation of controlling shareholders and entrenched
managers and their investment in value destroying negative NPV projects causes decreases
in firm value (Jensen, 1986; Stulz, 1990; Dittmar & Mahrt-Smith, 2007). Therefore, proper
corporate governance is needed to restrain controlling shareholders from appropriation of
firm resources and damaging firm value (Pinkowitz et al., 2006). The principles of corporate
governance issued by the Organization for Economic Co-operation and Development
(OECD) define corporate governance as “corporate governance involves a set of
relationships between a company’s management, its board, its shareholders and other
stakeholders”.
In history, the scandals of WorldCom, Enron and Taj Company Ltd in Pakistan and
recently 2017 scandal of Blue Bird Air Line Company of India are few examples of agency
problems causing destruction of firm value. Furthermore, the problem of agency is not
restricted to developed or developing economies or any particular industry. The controlling
shareholders and entrenched managers have a persistent tendency to miss-utilize firm
resources and ultimately destroy firm value. Therefore, proper governance rules and
regulation are vital to safeguard the shareholders.
Empirical evidence from literature shows that good governance has positive effect
on firm value. Pinkowitz et al. (2006) used international data and found that countries where
investors are less protected, cash holding posits a negative effect on firm value. On the other
hand, cash holding shows a positive effect on firm value in those countries where investors
51
are highly protected. In same way, Amman et al. (2011) conducted cross country research
and founded that good governance leads to low cash and positively affect firm value.
Similarly, Ararat et al. (2017) took Turkish companies for years 2006 to 2012 and found
that good corporate governance has positive and significant effect on firm value. On the
other hand, Kalcheva and Lins (2007) used international data and found that corporate
governance has no significant effect on cash holding and firm value. Chang, Benson, and
Falp (2017) investigated the relationship of cash holding and firm value relationship under
certain criteria (i-e., financial crises, financial constraint firms and corporate governance).
The result posits that cash holding have positive effect on firm value for financial constraint
firms but cash shows weak effect on firm value for financial constraint firms in crises
period. Furthermore, cash shows positive effect on firm value under good governance in
financial constraint firms.
Past researches have calculated firm value through Tobin Q using total asset. The
present research is unique in the sense that it analyzed firm value through cash instead of
total asset because cash is the most significant and valuable part of total assets. Therefore,
value impact through cash is most appropriate compared to Tobin Q (Faulkender & Wang,
2006). Moreover, cash is more easily spent by entrenched managers on their discretion
instead of other types of assets (Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et
al., 2013). Therefore, to investigate the effect of corporate governance on firm value through
cash is important and appropriate instead of considering firm value through other types of
assets (Dittmar & Mahrt-Smith, 2007). Pinkowitz and Williamson (2004) investigated
marginal value of cash using (Fama & French, 1998) methodology and measured value
through market to book ratio. They found that shareholders value cash high in those firms
whose growth opportunities are high and investment opportunities is volatile. Seifert and
Gonenc (2018) adopted the methodology of (Pinkowitz & Williamson, 2004) and their
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result posits that country level governance add to firm value but firm level corporate
governance posits insignificant effect on firm value.
Faulkender and Wang (2006) found value of cash through variation of financial
characteristics using methodology of (Fama & French, 1993) but they used excess equity
return instead of market to book ratio. Further, they divided all independent variables by lag
market value of firm. Pinkowitz et al., (2006) conducted research on international data and
found that cash has significantly increase value of firm in countries where investor’s
protection is high as compare to countries where investor’s protection is weak.
Corporate governance has significant positive effect on value of cash holding and
marginal value of cash is almost double as compare to firms with poor corporate governance
in USA (Dittmar & Mahrt-Smith, 2008). They adopted methodology of Faulkender and
Wang (2006) and shows that marginal value of cash to shareholders for 1USD is 1.62USD
in good governance firms compare to firms with poor governance is 0.42USD. In same way,
Jain et al. (2013) also found that corporate governance increase value of cash holding. On
the other hand, Ward, Yin and Zang (2018) shows that institutional investors increases value
of cash holding but only in those firms where institutional investors weighted investment
and stake is high. So, institutional investor motivation for monitoring plays key role in
increasing value of cash holding. Uddin (2016) conducted research in Japan and found that
foreign institutional ownership increases value of cash holding. Because foreign institutional
ownership has close monitoring on the activities of mangers and restrain mangers from
value destroying decisions which ultimately increase firm value. On the basis of above
discussion this research deduces the following hypothesis.
H2a: Corporate governance has positive and significant effect on value of cash holding
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2.2.1 Corporate governance, Product market competition and Value of cash holding
This study further investigated effect of corporate governance on value of cash
holding in competitive and concentrated industries whether the result varies in competitive
and concentrated industries. Cash is one of valuable asset for the firms that enable firm to
compete in competitive environment and increase firm value. Predation threat-based
theories propose that internal liquidity of funds safeguard firms from rival moves against the
firm without damaging interest of their minority shareholders (Alimov, 2014). On the other
hand, agency based theories propose contrary predictions that high cash in hands of
entrenched managers causes damage to the firm value because they utilize cash in their own
interest instead of serving the interest of shareholders (Jensen, 1986; Dittmar & Mahrt-
Smith, 2007). Bates, Chang and Chi (2018) investigated U.S firms and shows value of cash
holding increases over the period. They further shows that marginal value of cash for one
dollar was $0.61 in 1980 increases in 1990 to $1.04 and it was $1.12 in 2000. The increase
occurred due to various factors (e.g., cash flow volatility, product market competition and
decrease in diversification).
The role of product market competition is discussed by economists and argued that
external market discipline force managers to work efficiently in the best interest of
shareholders. Alchian (1950); Hart (1983) shows that competition increases operating
efficiency of firms by reducing cost of inputs. Shleifer and Vishny (1997) argue that,
“product market competition is probably the most powerful force towards economic
efficiency in the world.” There are two views on the role of product market competition in
the relation of corporate governance and firm value i.e., substitution hypothesis and
complementary hypothesis.
54
The substitution argument claim that good corporate governance has positive and
significant effect on value of cash holding in concentrated industries because external
market discipline is weak in concentrated industries as compared to the competitive
industries (Amman et al., 2011). Moreover, product market competition increases value of
firm despite of firm level of poor governance because competitive force is enough to
mitigate agency problem. On the other side, complementary hypothesis claim that good
governance increase value of cash holding in competitive industries compared to
concentrated industries. This means that external market discipline compensates and
complements good governance, needs efficient governance system to increase value of cash
holding. Chi and Su (2015) shows that value of cash is affected due to predatory threats
face by the firm from their rivals in product market. They show that firms whose predatory
threat is high their value cash holding is also high.
The empirical research conducted by Amman et al. (2011) on international data
suggests that corporate governance has significant positive effect on firm value in
concentrated industries but insignificant effect of corporate governance on firm value in
competitive industries. There result supported substitution argument of competitive pressure
for corporate governance in relationship with firm value. Similarly, Alimov (2014) found
that product market competition has significant effect on value of cash holding. He further
found that product market competition has strong and positive effect on value of cash for
firms that face perdition risk. However, his result shows no support of agency theory and
posits that competition has no effect in good governance and poor governance firms.
Schoubben and Hulle (2013) found that industry competition and industry concentration
both has effect on value of cash holding in weak governance firms. Industry competition and
industry concentration has insignificant effect on value of cash holding in strong governance
firms.
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On the other hand, Jain et al. (2013) supported complementary hypothesis of product
market competition for corporate governance in relationship with value of cash. They
further shows that corporate governance dummy 1 for good governance and 0 for poor
governance has significant positive effect on value of cash in competitive industries.
However, corporate governance has insignificant effect on value of cash holding in
concentrated industries. So, on the basis of previous literature we draw the following
hypothesis:
H2b: Product market competition has substitution effect for corporate governance in the
relationship between corporate governance and value of cash holding.
H2b: Product market competition has complementary effect for corporate governance in the
relationship between corporate governance and value of cash holding.
2.2.2 Corporate governance, Family ownership and Value of cash
Family owned businesses is important part of Pakistani economy. Due to agency
problem controlling shareholders misuse cash on the cost of minority shareholders in family
firms (Ward, 1987; La Porta et al, 1999; La Porta et al., 2000; Yeh et al., 2001).
Consequently, agency problem is high in family firms compared to non-family firms.
Therefore, proper governance is needed to mitigate agency problem in family firms to
increase firm value. Similarly, Boubakar, Derouiche, and Hassen (2015) conducted research
on French family firms and found that family ownership decreases value of cash holding
due to agency problem. Good corporate governance is important for family firms to control
agency problem especially when family businesses are passed to the next generation (Sarbah
& Xiao, 2015).
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On the other hand, Barontini and Caprio (2006) found that founding family firm
increase operating performance and family ownership has no significant relation with firm
value their result does not support agency theory. Mishra, Randoy, and Jensen (2001) found
that founding family ownership has positive effect on firm value, while corporate
governance has no effect on firm value in family firms. On one side, the presence of
controlling family mitigates agency problem between managers and shareholders by
meeting the interest of owners and managers. On the other hand, due to family ownership
another agency problem arise i-e., conflict between controlling shareholders and minority
shareholders (Shliefer & Vishney, 1997; Villalonga & Amit, 2006). The family firms want
to transfer their business to generation after generation. And force the controlling
shareholders to make decision that benefit family shareholders on the cost of minority
shareholders (Buchanan & Yang, 2005) and hamper firm value. Kalcheva and Lins (2007)
found that in firms with high managerial ownership, cash increase firm value when
governance is good but vice versa when external shareholding is low. Similarly, stock
markets react negatively when founder CEO of the firm pass family business to next
generation (Caprio, Giudice, & Signori, 2016). On the basis of the past literature this
research draws the following hypothesis:
H2c: Corporate governance has significant effect on value of cash holding in family firms.
2.2.3 Corporate governance, Shariah compliance and Value of cash holding
Shariah labeled firms are the firms which should meet minimum criteria of Shariah
already discussed in section 2.1.4. The research on corporate governance and value of cash
holding in Shariah compliant firms is negligible in corporate finance literature. Previous
researches show that good corporate governance effect efficient utilization of cash and
ultimately effect value of cash holding (Black, Kim, & Jang, 2006; Beiner et al., 2006;
57
Dittmar & Mahrt-Smith, 2007; Balasubramaniam, Black, & Khanna, 2009; Jain et al.,
2013). Shariah compliant firms are substitute to good governance due to their structure
(Ullah & Rizwan, 2018). The Shariah compliant firms maintain low debt maximum up to
37% and low debt is a substitute to good governance (Hayat & Hassan, 2017; Ullah &
Rizwan, 2018).
Previous researches investigated other financial decisions in Shariah and non-
Shariah compliant firms (e.g., Albdwy, Shah, & Salman, 2014) found that due to restriction
imposed, Shariah compliant does not hamper performance of companies in terms of ROA,
inventory efficiency etc. Moreover, Shariah compliant firms are able to compete with non-
Shariah compliant firms. In the same way Naz, Shah, and Kutan (2017) examined role of
top management on the financial decisions in Shariah compliant firms and non-Shariah
compliant firms using data of Pakistan and UK. They found that top managers take
significantly different financial decisions in Shariah and non-Shariah compliant firms
especially in terms of dividend payment, debt and working capital. Stock market is able to
attract reluctant Muslims for investment due to existence of Shariah compliant firms
(Omran & Pointon, 2004) that increase volume and trade of the market. This study is going
to evaluate effect of corporate governance on value of cash holding in Shariah compliant
firms and non-Shariah compliant firms.
H2d: Corporate governance has different effect on value of cash holding in Shariah
compliant and non-Shariah compliant firms and Shariah compliance is substitute to
corporate governance in relationship with value of cash holding relationship.
2.3 Excess cash and Usage
Utilization of excess cash is one of the most debatable questions in the field of
corporate finance because wasting of excess cash destroys value of firm. Excess cash is the
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difference of actual and predicted cash. The predicted cash is found as residual of regression
of determinants of cash holding i-e cash flow, industry adjusted cash flow volatility,
leverage, networking capital, size, dividend dummy, capital expenditure and market to book
ratio. The excess cash is calculated using Fama and Mechbeth regression following the
variables and work of (Opler et al., 1999).
2.3.1 Corporate governance and uses of excess cash
To finance day-to-day operations it is good to maintain some cash. Cash guards firm
from under investment problem and external financing because external financing is costly
compare to internal financing as suggested by the Hierarchy theory. However, excess cash
has negative effect on value of cash if entrenched managers or controlling shareholders use
it for their personal benefit due to agency problem (Harford et al., 2008; Jain et al., 2013). It
is preferable for firms to maintain high cash if the cost of maintaining high cash is zero
(Fulkender & Wang, 2006). Hierarchy theory supports this logic because internal financing
is cheapest as compare to external financing. However, maintaining excess cash is not cost
free because transaction cost and agency cost is related with maintaining excess cash
(Fulkender & Wang, 2006). Due to poor governance firms spend excess cash on value
destroying investments (Kusnadi, 2011).
Corporate governance effects utilization of excess cash due to which value of cash
holding increases (Ditmar & Mahrt-Smith, 2007; Harford et al., 2008). The three hypotheses
concluded by (Harford et al., 2008) explained the utilization of excess cash i-e., flexibility
hypothesis, spending hypothesis and shareholder power hypotheses. Flexibility hypothesis
suggest that due to agency problem firm’s managers want to maintain high excess cash and
do not invest excess cash to free managers from external market monitoring (Jensen, 1986).
Spending hypothesis claimed that due to agency problem managers involve in over
59
investment and disgorge excess cash on value destroying activities. Shareholder power
hypothesis suggest that whenever shareholders have power on the activities of managers;
prefer high cash to avoid under-investment.
The dissertation checked three ways in which managers disgorge excess cash
including internal investment, dividend, and diversification. Agency theory claims that
entrenched managers disgorge excess cash on value destroying capital expenditures that
benefits managers instead of shareholders. Jain et al. (2013); Harford et al. (2008) shows
that firms with good governance have lower tendency of disgorging excess cash on internal
investment measured by industry adjusted change in capital expenditure. Similarly, Amman
et al. (2011) also found negative effect of corporate governance on capital expenditure.
Next this research investigates the effect of corporate governance on dividend
payout. Dividend payment is less in developing economies compared to developed
economies (Glen et al., 1995). Firms with good corporate governance maintain less cash
because good governance distributes excess cash in form of dividend. According to agency
theory (Jensen & Meckling., 1976; Jensen, 1986) dividend distribution to the shareholders
reduce agency problem because it limited managers to use excess cash for their own benefit.
Laporta et al. (2000) found that countries where investors are highly protected, firms pay
high dividend as compare the firms belong to the countries where investors are less
protected pay low dividend. Two explanations exist in literature on dividend payout
substitution model and Outcome model (Kowalewski, Stetsyuk, & Talavera, 2007).
According to substitution model dividend is substitute to good governance and firms
with high agency problem, investors worry that excess cash can be destroyed on negative
NPV projects by entrenched managers for their own benefits. In that case investors prefer
that excess cash can be distributed in form of dividend to control agency problem. So,
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according to substitution model corporate governance and excess cash interaction has
negative effect on dividend. On the other hand, outcome model portray that firms with good
governance, investors and especially minority shareholders pressurize managers to distribute
excess cash in form of dividend to control over-investment problem. Minority shareholders
like dividend instead of retained earnings in that scenario when minority shareholders are in
position to put pressure on managers for distributing excess cash in form of dividend. On the
basis of outcome model corporate governance and excess cash interaction posits positive
effect on dividend. In line with this assumption, Harford et al. (2008) found that excess cash
and good governance dummy interaction has insignificant negative effect on industry
adjusted change in dividend, while excess cash and bad governance dummy interaction has
negative significant effect on industry adjusted change in dividend. Similarly, Pinkowitz et
al. (2006) found that dividend has positive and significant effect on firm value in poor
governance firms. In contrast Amman et al. (2013) found positive and significant effect of
dividend on firm value in good governance firms as compare to bad governance firms and
their result supported dividend outcome model. Siefert and Gonenc (2018) shows that
corporate governance decreases level of cash holding. Their result shows that excess cash is
distributed among shareholders in form of divided because shareholders in good governance
firms force managers to distribute dividend. They further found that dividend payment to
shareholders increases value of cash holding.
Third way that firm manager can disgorge excess cash is through diversification.
Diversification is major decision that is common occurrence in Asia. According to empire
building hypotheses, firms engage in value destroying diversification to create empire for
their selves which ultimately destroy value of firm. Managers disgorge excess cash in
negative NPV projects due to agency problem (Ditmar and Smith, 2008). Market responds
negatively to the firm engaging in unrelated diversification (Morck, Shliefer, & Vishney.,
61
1990). Agency explanation about diversification shows that due to corporate diversification
firm value decreases (Lang & Stulz, 1994; Comment & Jarrell, 1995; Berger & Ofek, 1995;
Servaes, 1996) because firms spend excess cash on value destroying diversification due to
agency problem. Similarly, Duchin (2010) found that diversified firms have less cash
compared to undiversified firms and especially diversified firms hold less cash when
corporate governance of diversified firms is good. Osech (2011) found corporate
governance has insignificant relation with corporate diversification. Firms with good
governance reduce spending excess cash on diversification. Keeping in view the above
discussion the following hypothesis is proposed:
H3a: Corporate governance has significant effect on utilization of excess cash
2.3.2 Corporate governance, Product market competition and Uses of excess cash
This research investigates the role of corporate governance on utilization of excess in
three ways in competitive and concentrated industries. . First, the utilization of excess cash
in the form of internal investment is considered. Excess cash utilization in form of
investment in the presence of competition is explained in the framework of two theories in
literature predation hypotheses and Agency theory. Predation hypotheses claimed that
competition in product market reduce predatory threats by investing in specific types of
investment (Haushalter et al., 2007). In contrast, agency hypothesis predicts that competition
in the product market force managers to work efficiently and restrain managers from value
destroying investments (Alimov, 2014).
Abdoh and Varela (2018) show that competition in product market force managers
on value investments. Bena et al. (2017) found that competition has significant effect on
capital expenditure. This research investigated effect of corporate governance on utilization
of excess cash in form of capital expenditure, dividend and diversification in competitive
62
and concentrated industries. Oesch (2011) found that corporate governance has insignificant
effect in competitive industries and significant effect in concentrated industries. He found
that corporate governance index and concentrated market dummy shows positive and
significant effect on capital expenditure. His study support substitution effect argument that
corporate governance has significant effect on capital expenditure only in concentrated
industries. Similarly, Jain et al. (2013) found that excess cash in competitive and
concentrated industries shows insignificant effect on industry adjusted capital expenditure.
The complementary hypothesis claim that corporate governance shows significant effect on
capital expenditure in competitive industries compare to concentrated industries.
Second, this research checked the role of corporate governance on utilization of
excess cash in form of dividend in competitive and concentrated industries. The outcome
model of dividend claim that dividend payment is high in competitive market, while
substitution model claim that dividend payment reduce agency problem and that dividend
payment is high in concentrated market. Kao and Chen (2013) found that dividend outcome
model is applied in highly competitive market and competition substitute governance in
Taiwan market. Haw, Ho, and Li (2011) found that countries where investor is less
protected distributed excess cash in form of share repurchases instead of dividend and
reduce marginal value of cash.
Third, this research investigates the role of corporate governance on spending of
excess cash in competitive and concentrated industries in form of diversification. The
research shows that firms normally engage in diversification due to agency problem (Tong,
2011). According to substitution effect argument, firms corporate governance has
significantly reduce spending of excess cash on corporate diversification in concentrated
industries compare to competitive industries. On the other hand, complementary effect
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argument claim that corporate governance significantly reduces utilization of excess cash on
diversification in competitive industries compare to concentrated industries. Atanasova,
Gatev, and Li (2015) investigated corporate diversification and cash holding relationship
and found that when governance is strong, diversified firms hold less cash compare to
undiversified firms. Furthermore, they found that when competition is high diversified firms
maintain more cash compare to stand alone firms. Similarly, Amman et al. (2011)
investigated effect of corporate governance on corporate diversification in competitive
industries and concentrated industries. They found that corporate governance has significant
effect on corporate diverisfication in concentrated industries compared to competitive
industries. Based on the preceding discussion the following hypothesis is proposed:
H3b: Corporate governance has significant role on utilization of excess cash in competitive
industries
2.3.3 Corporate governance, Family firms and Uses of excess cash
The extent literature shows that family businesses have high agency problems
because of lower performance than the non-family firms (Holderness & Sheehan, 1988). In
contrast, Anderson and Reeb (2003) found that family firms have high performance as
compare to non-family firms. La Porta et al. (2000); Yeh et al. (2001) found that family
firms have high agency problem due to which controlling shareholders expropriate firm
resources on the cost of minority shareholders. Corporate governance is needed to mitigate
agency problem for efficient utilization of excess cash in family firms.
Similarly, Boubakar et al. (2015) suggested that family ownership reduced value of
cash due to inefficient utilization of excess cash. Due to agency problem family firms
involve in investments that benefit to family members instead of whole shareholders
especially when family want to transfer business to next generation (Sarbah & Xiao, 2015).
64
This dissertation considers three way of disgorging excess cash i-e industry adjusted change
in capital expenditure, dividend and diversification in family firms.
Family firms have agency problem and involve in value destroying spending of
excess cash in form of industry change in capital expenditure that benefit particular family
on expense of minority shareholders. Good governance in family firms has significant role
in spending of excess cash on industry change in capital expenditure. Derouiche, Hassan,
and Amdouni (2018) `shows that controlling shareholders spend free cash flow less on
investment when the agency problem is low among controlling shareholders and minority
shareholders and vice versa.
The role of corporate governance on spending of excess cash in form of dividend in
family firms is largely ignored in extent literature of finance. Moreover, family firms due to
limited capacity of generating funds from external market prefer retained earnings
(Poutziouris, 2001) compare to dividend. Jensen (1986) claims that dividend is a tool
through which agency problem is mitigated. Moreover, family firms have not as much
savior agency problem between principle and agent (Gugler, 2003; Pindado, Requejo, & De
la Torre, 2012). However, family firms have normally high agency problem between
controlling shareholders and minority shareholders (Faccio, Lang, & Young, 2001; Pindado
et al., 2012). Dividend is a tool to mitigate minority shareholders concerns about miss-
utilization of excess cash. Whenever, firm level governance is good, minority shareholders
raise their voice and pressurize controlling shareholders to distribute excess cash in form of
dividend. Empirical evidence shows mixed result about dividend payment in family and
non-family firms (Chen et al., 2005). The results of Mcconaughy, Mathews, and Fialko
(2001); De Cesari (2009); Wei et al. (2011) shows that dividend payout is low in family
firms compare to non-family firms. In the same way, Duygun, Guney, and Moin (2018)
65
shows that firms with high agency problem prefer low dividend in order to maintain cash for
their discretionary use. They also show that family firms prefer low dividend due to high
agency problem in family firms.
On the other hand, Setia-Atmaja, Teneweski, and Skully (2009); Pindado et al.
(2012) shows that dividend payout is high in family firms compare to non-family firms. In
Pakistan, Shahid, Gul, Rizwan, and Bucha (2016) found that managerial ownership has
positive and significant relationship with dividend. Furthermore, their result shows that
ownership concentration also shows positive and significant relationship with dividend,
while board independence and board size shows insignificant relationship with dividend.
This research empirically investigated role of corporate governance on utilization of excess
cash in family and non-family firms. Whether, corporate governance has significant role in
utilization of excess cash in form of dividend payout in family firms.
As discussed earlier, the third way to disgorge excess cash is through diversification.
Controlling shareholders of family disgorge excess cash through diversification for empire
building for their family on cost of minority shareholders. As, family firms have high
agency problem especially when family is involved in management (Ward, 1987; La Porta
et al, 1999; La Porta et al., 2000; Yeh et al., 2001). Diversification due to agency problem
destroys resources and further destroys firm value (Lang & Stulz, 1994; Comment & Jarrell,
1995; Berger and Ofek, 1995; Servaes, 1996). Family member involve in family altruism to
transfer their business to their heirs as next generation destroy resources of firm and make
such decisions that give benefit only to particular family (Caprio et al., 2016). So, to fulfill
empire building for family and for the next generation family members, family firms
involve in diversification. Proper corporate governance is needed to alleviate agency
66
problem in family firms and thus this research proposed that excess cash under good
governance show negative relationship with diversification in family firms.
H3c: Corporate governance has significant role on utilization of excess cash in family firms.
2.3.4 Corporate governance, Shariah compliance and Uses of excess cash
Shariah compliant firms followed the rules of Shariah, while conducting business
activity and should pass certain criteria as previously discussed in detail. Good governance
enables efficient spending of excess cash (Dittmar & Mahrt-Smith, 2007; Jain et al., 2013;
Balasubramaniam et al., 2009). Shariah compliance is alternative of corporate governance
(Hassan & Hayat, 2017; Ullah & Rizwan, 2018). So, Shariah compliance is alternative to
corporate governance on the basis of these ground, research proposed that Shariah
compliant firms efficiently utilize excess cash and effect firm value. Dividend payment is
high in Shariah compliant firms compare to non-Shariah compliant firms (Farooq & Tbeur,
2013). Shariah compliant firms not only have high dividend payout ratio but also have
likelihood for dividend payment (Farooq & Tbeur., 2013). According to substitution effect
argument Shariah compliance is substitute to corporate governance. On the basis of this
argument corporate governance has insignificant effect on utilization of excess cash in
Shariah compliant firms as compare non-Shariah compliant firms.
H3c: Corporate governance has different effect on utilization of excess cash in Shariah and
non-Shariah compliant firms.
2.4 Excess cash, corporate governance, and Total factor productivity growth
Firms waste excess cash due to agency problem that causes decline in performance
of the firm. Dittmar and Mahrt-Smith (2007) shows that excess cash under good governance
increase operating performance and vice versa. Excess cash is wasted by entrenched
67
managers and controlling shareholders for their personal benefit due to agency problem
which consequently decreases operating performance of the company. Proper corporate
governance helps in mitigating agency problem that result in expropriation of excess cash by
entrenched mangers and controlling shareholders (Dittmar & Mahrt-Smith, 2007).
Harford et al. (2008) found that lag excess cash and change in excess cash both
reduce current operating profit of firm. And interaction term of lag excess cash and good
governance dummy has negative relationship with the current industry adjusted profitability
of a company. They explained negative relation in terms of mean reversion of profitability
in long run. Simutin (2010) shows that high excess cash leads to high investment and has
insignificant relationship with future profitability and claimed that it may be due to over-
investment. Jain et al. (2013) portray that excess cash has significant negative effect on
industry adjusted ROA, while governance has insignificant effect on the excess cash and
profitability relationship. This research used the concept of total factor productivity growth
to measure performance of firm. “Productivity as the residual production output beyond the
contribution of input costs is arguably a better measure of the firm's real economic
performance” (Tian & Twite, 2011). Total factor productivity growth is a better measure for
performance than the traditional accounting measures because accounting ratios have higher
chance of manipulation (Barth et al., 2005).
Poor governance tends to decrease productivity growth (Holmstrom & Kaplan,
2005). On the other hand, good governance increases total factor productivity growth by
increasing firm allocated efficiency and encourage managers to invest in value enhancing
investments by keeping cost of capital low (Min & Smyth, 2012). Gaitan, Echeverri, and
Pablo (2018) shows the effect of corporate governance on productivity of Latin American
companies and the result posits that corporate governance effect productivity of firms. This
68
research contributes to existing literature by investigating effect of excess cash with good
corporate governance on total factor productive growth. Excess cash with good corporate
governance increases operating profit because good governance ensures efficient utilization
of excess cash (Dittmar & Mahrt-Smith, 2007). The role of good governance on excess cash
and total factor productivity growth is ignored in literature. This research contributes to the
extant literature by investigating effect of excess cash on total factor productivity growth,
and the role of governance in the relationship of excess cash and total factor productivity
growth. On the basis of this argument this research develops following hypotheses.
H4a: Excess cash with good corporate governance positively affect total factor productivity
growth.
2.4.1 Excess cash, Corporate governance, Product market competition and Total factor
productivity growth
It has been discussed that product market competition is external market discipline to
mitigate agency problem between managers and shareholders and increase performance of a
firm (Alchian 1950; Stigler 1958). Competition in product market force managers to work
efficiently and decrease slack of managers (Hart, 1983; Shleifer &Vishny 1997; Allen &
Gale, 2000). Product market competition leads to high total factor productivity growth,
while concentration leads to low total factor productivity growth (Nickell, 1996). Schmidt
(1997) discussed that “other things remaining constant” the output prices reduces due to
competition resulting in the risk of liquidation. Therefore, managers of the firm feel pressure
and work efficiently. Grossfeld and Tressel (2001) found that high competition leads to high
total factor productivity growth using data of polish companies. Similarly, Januszewski et
al. (2002) conducted research in Germany using panel data approach and found that intense
competition increases productivity.
69
On the basis of above discussion it is concluded that competition in product market
leads to increase total factor productivity growth. The role of competition on the corporate
governance and total factor productivity growth is discussed in literature. Two views
presented in literature support the role of governance in competitive and concentrated
industries i-e complementary and substitution effect. According to complementary
hypothesis, corporate governance has significant role in determining the excess cash and
total factor productivity growth in competitive industries. On the other hand, the substitution
view suggests an insignificant role of governance in the relationship of excess cash and total
factor productivity growth in competitive industries because external market discipline is
enough to mitigate agency problem. The substitution hypothesis shows that corporate
governance has significant role in determining excess cash and total factor productivity
growth in concentrated industries compare to competitive industries.
Tian and Twite (2011) conducted research on Australia firms they used data from
years 2000 to 2005 and found that product market competition has substitution effect to
good governance with total factor productivity relationship. They found that external market
discipline increase total factor productivity growth even though firm level governance is
low. Aghion and Howitt (1997) also found that competition has substitution to governance
with total factor productivity relationship. In contrast, Selarka (2014) conducted research on
Indian firms and found weak form of substitution effect of competition for corporate
governance. He suggested that along with competition efficient corporate governance is
needed to improve performance in Indian firms. Januszewski et al. (2002) found that
competition has positive and significant effect on total factor productivity growth and
competition has positive and significant effect on total factor productivity growth for good
governance firms. Their research supported complementary hypothesis of competition with
corporate governance. Similarly, Koke et al. (2001) using data of German firms found that
70
competition has significant effect on total factor productivity in firms having concentrated
ownership. On the other hand, Koke and Renneboog (2005) conducted research using data
of UK and German firms, and found complementary effect of competition for good
corporate governance in relationship with total factor productivity growth. On the basis of
previous researches this research develops the following hypothesis:
H4b: Corporate governance has significant role on excess cash and total factor productivity
growth in competitive industries.
2.4.2 Excess cash, Corporate governance, Family ownership, and Total factor
productivity growth
Agency conflict arises due to division between owners and managers. Disagreement
between owners and managers are classic example of agency problem. In family firms the
conflict between manager and shareholders are less compare to non-family firms (Pindado
et al., 2012) because family members want the business to survive and work as stewards for
the business. On the other hand, a second type of agency problem between controlling
shareholders and minority shareholders is high in family firms compare to non-family firms
(Kuan et al., 2011) and miss-utilization of excess cash that benefit to particular family
members leads to low performance.
Research shows that excess cash is miss-utilized by the controlling shareholders for
their own interest and for the interest of particular family which hampers the performance of
company. Min and Smyth (2012) found that managerial ownership and corporate
governance interaction increases total factor productivity growth. On the other hand,
Cronqvist and Nilsson (2003) conducted research on Swedish firms and concluded that
family ownership decreases the performance of company due to agency problem. Morck,
Shleifer, and Vishney (1988) found non- linear relationship between managerial ownership
71
and firm performance and measured firm performance through average Tobin Q. In contrast,
Yaseer (2011) investigated effect of corporate governance on firm performance in family
and non-family firm; there result posits that corporate governance has significant role on
firm performance in both family and non-family firms. Barth et al. (2005) investigated effect
of family ownership on total factor productivity. Moreover, they investigated the role of
management on family ownership and total factor productivity. Their result shows that
family firms are less productive compared to non- family firms particularly when the firm is
managed by family members. On the other hand, if family firms hired outsider to manage
firm than family firm and non-family has no significance difference in productivity.
The family firms normally do not want to dilute their ownership and are normally
reluctant in raising new funds through equity financing. Moreover, debt financing is also
low in family owned firms (Agrawal & Nagarjan, 1990; Gallo & Vilaseca, 1996). This
approach makes family firms less productive compared to the non-family firms (Barth et al.,
2005) and decrease overall value of firm. Family members due to agency problems, tend to
work in their personal interest (Yeh et al., 2001) and decrease total factor productivity
growth which ultimately decrease overall value of firm. Therefore, corporate governance
has significant effect on excess cash and total factor productivity growth in family firms. On
the basis of previous studies this research can draw following hypothesis:
H4c: Corporate governance has significant effect on excess cash and total factor
productivity growth in family firms.
2.4.3 Excess cash, Corporate governance, Shariah compliance, and Total factor
productivity growth
This dissertation also investigated role of corporate governance on excess cash and
total factor productivity growth relationship in Shariah and non-Shariah compliant firms.
72
Islam does not prohibit profit and risk minimization but the source of profit must be halal.
The objective of profit is associated with the ethical system of Islam (Noreen, 1988; Rice,
1999; Ali et al., 2013; Emerson & McKinney, 2010). Business according to Islamic
principles and its ethics is much more associated to the moral filter (Rice, 1999). Ethical
system of Islam provides proper guidance for businessman to conduct business in real world
(Ramli & Ramli, 2016). In Islamic ethical system exploitation and overpricing for unjust
profit maximization is discouraged. Hadith of Prophet Muhammad (SWA) “Allah is One
Who fixes prices, Who withholds, Who gives lavishly, and who provides. And I hope that
when I meet Him, none of you will have a claim against me for any injustice with regard to
blood or property”.
. According to substitution effect argument the effect of corporate governance on
excess cash and total factor productivity growth is insignificant in Shariah compliant firms.
Shariah compliant firms have low agency problems due to their structure. Therefore,
managers efficiently utilize excess cash and increase total factor productivity growth.
Lusyana and Sherif (2017) conducted research in Indonesia and found that Shariah
compliance increases the financial performance. Moreover, the investment incurred by
Shariah compliant firms increases their financial performance and stock return.
Kamau (2016) compares the Shariah index with non-Shariah index and found that
performance of Shariah index is better in terms of return per unit risk, excess return and risk
adjusted return compared to non-Shariah index. The work on Shariah compliant firms is
still nascent. Shariah compliant firms have low agency problem. Therefore, consistent with
the substitution effect argument, effect of corporate governance on performance is low in
Shariah compliant firms compared to non-Shariah compliant firms. On the basis of above
73
discussion this research concludes that corporate governance shows insignificant role on
excess cash and total factor productivity growth in Shariah compliant firms.
H4d: Excess cash with good corporate governance has different effect on total factor
productivity growth in Shariah and non-Shariah compliant firms.
Among the three way of spending excess cash i-e industry adjusted change in capital
expenditure, dividend and corporate diversification the important way of spending excess
cash in Pakistan is corporate diversification. The result of this dissertation also proved that
due to agency problem firms involve in corporate diversification that destroys the firm
value. So, the effect of corporate diversification on firm value is important.
2.5 Corporate governance, Diversification and Value of cash
Economists extensively argue that diversification and firm value is related. There is a
debatable literature available in finance that evaluates whether corporate diversification
decreases value of firm. For example, Lang and Stulz (1994); Berger and Ofek (1995) found
that due to corporate diversification value of firm is destroyed because firms involve in
diversification due to agency problems and underutilize excess cash on diversification.
Similarly, Lins and Serveas (1999) conducted research on European economies and found
that value of firm is reduced due to diversification. Moreover, Doukas and Kan (2006)
conducted research in US market and found that value of firm is reduced up to 12% due to
diversification. While, Hund, Monk, and Tice (2010) used global sample and found that
corporate diversification causes 11% reduction in value of firm. Similarly, Cleasssens,
Djankow, Fan, and Lang (1998); Lins and Servaes (2002) targeted Asian markets and found
that value of firm is reduced in Asian economies up to 14% to 16% due to diversification.
Espinosa et al. (2018) found that diversification exerts negative effect on firm value and the
74
negative relationship of diversification and firm value is reversed in the presence of pension
fund administrators and family ownership. Furthermore, presence of large institutional
ownership is unable to reverse the negative relationship of corporate diversification and firm
value.
On the other hand, few researchers found insignificant effect of diversification on
value of firm (e.g., Glaser & Muller, 1998; Zahavi & Lavie 2013). On the contrary, few
researchers like Villalonga (2004); Lee, Hooy, and Hooy (2012) found that diversification
increase value of firm. Diversification has different effect on value of firm in different
economies due to difference in governance structure. Diversification can decrease
performance due to agency cost and information asymmetry (Stein, 1997; Stulz, 1999;
Khanna & Palepu, 2000; Rajan et al., 2000; Campa & Kedia, 2002). Corporate
diversification and firm valuation is negatively related due to agency problem. Denis et al.
(1997) found that diversification reduces value of firm mainly due to agency problem.
Similarly, Riswan & Suyono (2016) investigated effect of diversification and family
ownership on firm value in Indonesia and found that diversification exert negative effect on
firm value, while family ownership shows insignificant effect on firm value. Diversified
firms involve in cross-subsidization to transfer excess cash from profitable projects to less
profitable projects and ultimately destroy value of firm (Lang & Stulz, 1994; Berger &
Ofek, 1995).
The agency explanation of diversification shows that firms expropriate in the form of
diversification for their private benefits (Jensen, 1986). Therefore, good corporate
governance is needed to mitigate agency problem for expropriation of excess cash in form
of diversification. Tong (2011) suggests that diversification is negatively related to value of
cash due to agency problem in lower governance firms, while it has positive but
75
insignificant effect on value of cash holding in good governance firms. He further shows
that marginal value of diversified firms is $0.93 for $1 to the shareholders compare to $1.08
for $1 in undiversified firms and diversification reduces value of cash. Furthermore, his
research shows that good governance increase marginal value of cash to $1.19 from $0.93 in
diversified firms compared to single segment firms whereas, good governance increases
marginal value of cash to $1.20 from $1.08. On the other hand, diversified firms with poor
governance have $0.57 marginal value of cash, while it is $0.86 in single segment firm with
poor governance. On the basis of this argument the research deduces the following
hypothesis.
H5a: Diversification reduces value of cash holding due to agency problem
H5b: Diversification increase marginal value of cash holding in good governed firms and
reduce marginal value of cash holding in poor governed firms due to agency problem.
2.5.1 Corporate diversification, product market competition, and value of cash holding
Product market competition acts as external market discipline to mitigate agency
problem and put pressure on managers to work efficiently in the best interest of shareholders
(Amman et al, 2011; Jain et al., 2013; Alimov, 2014). Researches including Lang and Stulz
(1994); Berger and Ofek (1995); Cleasssens et al. (1998); Tong (2011) suggest that
diversification reduces value of firm due to agency problem. Explanation from the
perspective of agency problem suggests that inefficient spending of corporate resources on
diversification particularly excess cash reduces value of firm. Product market competition
mitigate agency problem and is therefore expected to reverse the negative effect of corporate
diversification on value of cash holding. Therefore, keeping in view the above literature this
study can conclude the following hypothesis:
76
H5c: Corporate diversification has positive effect on value of cash holding in competitive
industries
2.5.2 Corporate diversification, Family firms, and Value of cash holding
According to internal market hypothesis family firms involve in cross-holding,
transferring funds from one place to another where good investment opportunities are
available within family group (Khanna & Palepu, 2000; Anderson & Reeb, 2003; Claessens,
Fan, & Lang, 2006). Moreover, diversification gets benefit from efficient internal market to
relocate finances to good investment opportunities project (Tong, 2011). On the other hand,
agency theory (Jensen, 1986) suggests that family firms due to serving particular family
transfer financing to low investment opportunities projects and even to negative NPV
projects that ultimately destroy value of firm. The Latest scandal is an example of this
phenomenon, where CEO Vajay Malia of family firm in India got involved in unrelated
diversification of airline business from alcoholic beverage business and as a result the firm
value destroyed and the firm faced bankruptcy.
Therefore, the cost of diversification is high due to agency problem where
entrenched managers involve in diversification due to serving their personal interest and
destroy value of firm (Bergen et al., 1992; Koch & Nafziger, 2012). Managerial ownership
destroys value of firm because firms with high managerial ownership involve in bad
diversification due to agency problem (Morck et al., 1988; Lins & Serveas, 2002). When
family firms involve in diversification destroy value of firm because family firms have
agency problem and tend to serve interest of particular family. Therefore, family firms
involve in diversification that benefit to their family members (Brahmana, Setiawan, &
Hooy, 2014). Keeping in view the preceding discussion this research can conclude
following hypothesis.
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H5d: Diversification reduces value of cash holding in family firms.
2.5.3 Diversification, Shariah compliance, and value of cash holding
Diversification reduces value of firm due to agency problem (Denis et al., 1997).
However, as discussed earlier diversification increases value of cash holding in the presence
of good governance (Tong, 2011). Therefore, it can be stipulated that it reduces value of
cash holding in case of poor governance. Since, Shariah compliant firms should fulfill
certain requirements to differentiate from non-Shariah compliant firms. Therefore, Hayat
and Hassan (2017) claim that corporate governance is good in Shariah compliant firms.
Similarly, the substitution effect argument also suggests that Shariah compliance is
substitute to good governance. On the basis of the grounds that Shariah labeled firm is
substitute to good governance this research postulates the following hypothesis:
H5e: Diversification increases value of cash holding in Shariah compliant firms.
2.6 Theoretical framework
Cash has gained more importance after the financial crises of 2008 because those
firms have survived during crises period whose internal liquidity was sufficient. Purpose of
holding cash by firms was explained by Keynes (1936). He explained three purposes of
cash holding 1) transaction motive 2) precautionary motive 3) speculative motive.
Transaction motive shows that firm holds cash for day to day finances, while precautionary
motive claim that firms hold cash to secure themselves from external shocks. Therefore,
cash buffers firms in crises periods where generation of external finances is difficult or
costly. Speculative motive of cash holding explain that firms hold cash to avail sudden
78
opportunities arising in the market. Holding cash is also explained through financial
hierarchy theory which explains that internal funds are cheapest source of finance.
Holding cash is beneficial for firms but some cost is attached with the cash holding.
The important cost that is related with holding extra cash is agency cost. Entrenched
managers destroy cash for their personal interest on cost of shareholders and hence destroy
value of firm (Ditmar & Mart-Smith, 2007; Harford et al., 2008; Amman et al., 2013).
Proper corporate governance is needed to force managers to work in best interest of
shareholders who are the real owners of the firm. This research uses the lens of Agency
theory (Jensen, 1986) to explain the relationship of corporate governance with the level,
value, and utilization of cash.
The corporate governance and cash relationship is explained on the basis of three
hypotheses including the flexibility hypothesis, spending hypothesis and the shareholder
power hypothesis (Harford et al., 2008). According to flexibility hypothesis entrenched
managers due to high agency problem between managers and shareholders, hold cash to
safeguard themselves from external market discipline and monitoring. Therefore, corporate
governance has negative relationship with cash holding. On the contrary, according to
spending hypotheses due to agency problem entrenched managers spend excess cash on
value destroying investments and reduce level of cash. Therefore, corporate governance
shows positive relationship with cash holding. On the other hand, according to shareholder
power hypotheses with good governance shareholder has confidence on managers that they
will not destroy excess cash on value reducing investments. Consequently, corporate
governance has positive effect on cash holding.
Similarly, the role of competition in product market in relationship of corporate
governance and cash holding is supported on basis of substitution and complementary
79
hypotheses. According to substitution effect argument competition in product market work
as external market discipline to mitigate agency problem between shareholder and mangers
and force managers to work in the best interest of shareholders even if firm level governance
is poor (Amman et al., 2013; Jain et al., 2013). Therefore, good governance does not have
important role in competitive industries compared to concentrated industries where external
market discipline is weak. On the other hand, according to complementary hypothesis
efficient internal governance is needed with competition because competition alone is
insufficient to reduce agency problem. Therefore, on the basis of complementary argument
corporate governance has significant effect in competitive industries.
The effect of corporate governance on cash holding in family and non-family firms
is also important to consider. Family firms involve in family altruism and want to transfer
business to their next generation. Therefore, they make decisions that are beneficial to
family members on cost of minority shareholders (Yeh et al., 2001; Kuan et al., 2011).
Therefore, corporate governance has significant effect on cash holding in family firms as
compare to non-family firms to reduce agency problem.
Similarly, Shariah compliance can also affect the relationship of corporate
governance and cash holding. The extant literature suggests that Shariah compliant firms
have low agency problem due to their structure. Therefore, Shariah compliance is alternate
to good governance (Hayat & Hassan, 2017). Hence, according to substitution effect
argument corporate governance has no significant role on cash holding in Shariah compliant
firms
Similarly, corporate governance is also an important determinant of value of cash
holding. Agency problem arise due to conflict of interest between managers and
shareholders that reduces value of cash due to wastage of excess cash for their own benefit.
80
.So, corporate governance increases value of cash holding because corporate governance
significantly effect on efficient utilization of excess cash (Dittmar & Mahrt-Smith, 2007;
Pinkowitz et al., 2006). The effect of corporate governance on value of cash holding and
efficient utilization of excess cash in competitive industries and concentrated industries is
supported by substitution and complementary effect argument. According to the substitution
effect argument, corporate governance has insignificant effect on value of cash holding and
utilization of excess cash which affects value of cash holding. On the other hand, the
complementary argument explains that corporate governance has significant effect on value
of cash holding and utilization of excess cash in competitive industries.
Furthermore, corporate governance has also significant positive effect on value of
cash holding in family firms compare to non-family firms because family firms have
comparatively higher agency problem (Yeh et al., 2001). Therefore, good governance
reduces agency problem and ultimately increases value of cash holding through efficient
utilization of excess cash. Similarly, since Shariah compliance is substitute to good
governance; therefore good governance has insignificant effect on value of cash holding in
Shariah compliant firms. Moreover, corporate governance has also insignificant effect on
efficient utilization of excess cash in Shariah compliant firms.
The extant literature also shows that corporate diversification reduces value of cash
holding due to agency problem (Jensen, 1986). Entrenched managers and controlling
shareholders involve in diversification for empire building on the cost of minority
shareholders. However, diversification has significant positive effect on value of cash
holding in good governed firms and negative effect on value of cash holding in poor
governed firms (Tong, 2011). Therefore, to reduce agency problem proper governance
81
system is needed. Furthermore, competition work as external market discipline and reduce
agency problem.
Therefore, diversification has positive effect on value of cash holding in competitive
industries and negative effect in concentrated industries because external market discipline
is external market force to mitigate agency problem. Diversification in competitive
industries is not value destroying compare to concentrated industries. Similarly,
diversification has negative effect on value of cash holding in family firms. Family firms
involve in diversification under empire building and want to transfer their businesses to next
generation. Therefore, they involve in diversification to benefit particular family members at
the cost of minority shareholders. Therefore, family firms involve in diversification is not
value enhancing due to agency problem. Similarly, the Shariah compliant firms cannot
increases their debt and liquidity from particular target ratio to meet the requirements of
Shariah compliance. Shariah compliance firms due to its structure has low agency problem
compare to non-Shariah compliance firms (Hayat & Hassan, 2017). Therefore,
diversification has either positive or insignificant effect on value of cash holding in Shariah
compliant firms.
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CHAPTER 3
METHODOLOGY
This section includes methodology of dissertation. It includes population, sample size,
variables measurement and analytical models
3.1 Population and Sample size
The governance data is taken from annual reports, while the accounting data is taken
from balance sheet analysis published by state bank of Pakistan from years 2006 to 2014.
Our population consists of 392 companies from various sectors listed on Pakistan stock
exchange (PSX). Sample consists of 196 companies through proportionate sampling
technique. Those industries are selected which have minimum seven firms operating in
industry. Furthermore, miscellaneous sector is ignored because same types of firms are not
operating in this sector. The sample is divided into competitive industries and non-
competitive industries; family and non-family firms; Shariah and non-Shariah compliant
firms respectively. The details of sample firms with respect to their affiliation with different
industrial groups/sectors are reported in Table 3.1.
�1 = �1N ∗ �
�1 = �ℎ �� �� �� �� �� ����� ��� ���������� �����
�1 = �ℎ �� �� ��� �� �ℎ �����
N = The size of population
� = �ℎ �� �� �� ��� � �������* �� ���������� �����
83
Table 3.1: Sample size
INDUSTRIES POPULATION SAMPLE
AUTOMOBILE ASSEMBLER 12 6
AUTOMOBILE PARTS & ACCESSORIES 9 5
AUTOMOBILE PARTS & ACCESSORIES 8 4
CEMENT 22 11
CHEMICAL 28 14
ENGINEERING 18 9
FERTILIZER 7 4
FOOD & PERSONAL CARE PRODUCTS 20 10
GLASS & CERAMICS 11 6
OIL & GAS MARKETING COMPANIES 7 4
PAPER & BOARD 9 5
PHARMACEUTICALS 9 5
POWER GENERATION & DISTRIBUTION 19 10
SUGAR & ALLIED INDUSTRIES 35 18
SYNTHETIC & RAYON 11 6
TECHNOLOGY & COMMUNICATION 10 5
TEXTILE COMPOSITE 56 28
TEXTILE SPINNING 87 44
TEXTILE WEAVING 14 7
Total 392 196
3.2 Variables of the study
3.2.1 Cash Holding
+��ℎ ℎ�����* = Cash and Cash equilentsTotal Asset − Cash and Cash equilents
The ratio is used in majority of studies like (Ditmar & Mahrt- Smith, 2007; Harford et al.,
2008; Jain et al., 2013)
3.2.2 Corporate governance measurement
Corporate governance data is collected from yearly annual reports of individual
companies downloaded from their respective websites. Those firms are excluded from the
sample whose data is missing for a particular year. The data for this research is the form of
unbalanced panel.
84
For the measurement of corporate governance this research used corporate
governance index (CGI). Corporate governance variables are adopted from Shah (2009).
Corporate governance index measure the quality of corporate governance in firm.
Governance index is measured from various firm level attributes which shows in below
table 3.2. This research measured additive index following the work of Aggarwal et al.
(2011); Amman et al. (2011); Uddin (2016) by dividing the score in 5 quintiles.
Governance index score lies between 1 to 5 and high score represent good
governance, while low score represent poor governance. To obtain robust result reverse
coding is used for negative attributes in index which indicates that increase in governance
score improve corporate governance. Corporate governance score is used to find out the
effect of corporate governance on cash holding. Moreover, to investigate the effect of
corporate governance on value of cash holding, governance dummy is used 1 for good
governance and 0 for poor governance. The dummy variable is used because in value of
cash holding regression interaction of corporate governance dummy and change in cash is
used following the work of (Faulkender & Wang, 2006; Dittmar & Mahrt-Smith, 2007).
The objective of the study is whether change in cash increase marginal value of cash under
good governance and reduce marginal value of cash under poor governance.
Moreover, researchers suggest that better way to create interaction term is that one
variable is in continuous form and other is in dummy form because it is easy to interpret
whether change in cash add value to the firm under good governance. Furthermore,
governance dummy is also used in interaction of lag excess cash and corporate governance
dummy to find its effect on utilization of excess cash and performance of firm under good
governance. Corporate governance dummy is created by dividing the firm’s governance
index into 3 terciles. The highest tercile is given 1 for good governance and lowest and
85
middle tercile is given 0 for poor governance in particular year. Table 3.2 reports the
corporate governance variables used for CGI.
Table 3. 2: Corporate Governance Variables
Ownership
Structure
OS Shares held by board of
directors/ Total no. of shares
outstanding
Board Size BS Ln. of total No. of Board
members.
Board
Independence
BI Non-Executive Directors/
Total No. of Directors in
board
Audit Committee
Independence
Audit committee size
ACI
ACS
Non-Executive directors in
Audit committee/ Total
Audit size
No. of Directors in Audit
Committee
CEO Duality
Board meeting
CEOD
BM
Whether CEO and Chairman
is the same person.
Number of board meeting
per year
3.2.3 Diversification measurement
Firm diversification is measured when the group of firms is operated in different
industries like Sitara chemical limited and Sitara textile limited. Dummy variable is used
for diversification with 1 for diversified firms and 0 for standalone firms.
86
3.2.4 Product market competition
As, per previous literature product market competition is measured through
Hirfindahl-Hirschmann Index (HHI) (Masulis et al., 2007; Giroud and Mueller, 2010, 2011;
Amman et al., 2013; Jain et al., 2013; Alimov, 2014). HHI is concentration measure and
computed by dividing total sales of company in a particular year by total sales of the
industry to which the firm belongs and square that market share of all firms in particular
industry for particular year. Sum square of all market shares of all industries are divided in
terciles. Moreover, firms in particular year belong to lowest tercile industries is assigned 1
for competition and otherwise 0 for concentration. This research exclude firm in particular
year whose sales figure are missing. The binary value of 1 and 0 is used because to divide
industries in particular year in competitive and concentrated and check the substitution and
complementary effect of product market competition for corporate governance in various
relationships.
Shariah compliance is captured through dummy variable with 1 for Shariah
compliant firms and 0 for non-Shariah compliant firms. Data for Shariah compliant firms is
collected from PSX-KMI.
Family ownership is measure on the basis of certain criteria (1) if insider has 25% or
more ownership suggested by (Kuan et al., 2011) (2) if the firm CEO or Chairman is
founder or successor is assigned for family and 0 for non-family firms.
3.2.5 Control variables
This research takes data for financial ratios from years 2006 to 2014 from the annual
reports and balance sheet analysis of Pakistan. The control variables are selected on the
basis of precautionary motive of cash holding used by (Opler et al., 1999) and variables is
87
further used by various researchers (like- Dittmar et al , 2003; Aggarwal et al., 2011; Shah,
2011). The control variables for corporate governance and cash holding relationship are as
following:
i. Cash flow is measured as the profit after tax and dividend but before depreciation, divided
by net assets
���ℎ���1 = net profit before tax − tax expense − dividendtotal asset − cash
ii. Industry cash flow volatility is measured through standard deviation of past 3 years cash
flow and calculated the median standard deviation of each industry for each year and then
subtract industry median from the standard deviation of each firm cash flow on yearly basis.
iii. Market to book ratio measured the growth opportunities of the firm
��7� �� ���7 ����� = Market value of assetBook value of asset
iv. Leverage ratio shows total debt to book value asset ratio which shows total debt financing of
the firm in particular year.
�;��* = Total debtBook value of assets
v. To measure Net working capital current liabilities are subtracted from current asset and
divided by book value of asset
�� 1��7��* ������� = Current Asset − Current Liabilitiestotal asset − cash
vi. Size of the firm is measured as natural log of the book value of asset
Size = ln(Total asset)
vii. Capital expenditure is measured as annual change in fixed assets plus annual change in
depreciation divide by net assets
+��= = Δ annual fixed asset + depreciation chargestotal asset − cash
88
Dividend is dummy variable which is equal to1 if firm pays dividend in particular year
otherwise 0.
3.3 Panel data analysis
3.3.1 Static model
Panel data technique is used for the analysis of data. Panel data technique has
advantage over cross-section and time series data due to heterogeneity. Panel data has low
chances of heterogeneity compared to cross-sectional and time series data (Baltagi, 2008).
Furthermore, multicolineairity problem is less in panel data compared to time series and
cross sectional-data (Baltagi, 2008). According to Peterson (2006) 42% of research papers
in finance do not care about the independence of residual. If residual is identical and
independent than OLS estimates is unbiased otherwise OLS estimates are biased. And if
both firm fixed effect and time effect exist the phenomenon can be captured for unbiased
standard error by including time dummies and cluster by firm or industry (Peterson, 2006).
This study follows this phenomenon by including time dummies, industry fixed effect and
standard error cluster to firm. The phenomena are also used by various researchers, while
investigating effect of corporate governance on cash holding (e.g., Harford et al., 2008; Jain
et al., 2013; Alimov, 2014; Uddin, 2016). The problem of endogeneity also exists in the
relationship of corporate governance and cash holding because corporate governance and
cash is jointly determined (as suggest, Harford et al., 2008). The OLS estimation is not fully
able to control endogeneity problem and to counter endogeneity problem dynamic panel
model is used in previous researches.
89
3.3.2 Dynamic model
Dynamic model involves dynamic effect in panel model by adding lag of the
dependent variable in the regression. The dynamic panel data model gives more
generalizable results in panel data (Wooldridge, 2001). Two models among the dynamic
panel models are extensively used in finance literature i-e.; two stage least square (2SLS)
and generalized least square model (GMM). 2SLS estimation required instrumental
variables but the problem is that past researches used identical variables in the relationship
of corporate governance and cash holding. So, it is difficult to find proper instrumental
variables for the relationship of corporate governance and cash holding (Harford et al.,
2008). So, GMM is superior approach which does not require instrumental variables. Two
approaches are widely used in literature for GMM including the Arellano-Bond and
Arellano-Bovver approach. Individual effect built-in differently in both approaches,
Arellano-Bond method follows differencing approach, while Arellano-Bovver approach
follows orthogonal deviations. In recent research Arellano-Bovver method is normally used
due to strength for small sample size and it is also good when data is non-stationary.
3.3.2.1 Instrumental validation
Validity testing is required for both system GMM and difference GMM. Arellano
and Bond (1991) suggested test for serial correlation in disturbance effect because
disturbance effect of serial correlation sometime affects validity of instruments. The null
hypothesis for this test is that there is no autocorrelation. The second test is for identification
of over-identification problem through Sargan test (Sargan., 1958). The null hypothesis of
the test is over-identification restrictions are valid.
90
3.4 Analytical model
The following basic analytical models are used;
+��ℎ ℎ�����*A,C =∝ +EF����1A,C + EG+HIA,CJF + EK L��MA,C + EN �O+A,C
+EP���A,C + EQ�;��*A,C + ERS+A,C ∗ +HIA,CJF + ETS+A,C + EU����;���A,C + EFVW�;A,C +EFF���=A,C + �A,C………………………………………………………..(3.1)
+��ℎ ℎ�����*A,C =∝ +EF����1A,C + EG+HIA,CJF + EK L��MA,C + EN �O+A,C
+EP���A,C + EQ�;A,C + ER�� ���A,C ∗ +HIA,CJF + ET�� ���A,C + EU����;���A,C +EFVW�;A,C + EFF���=A,C + �A,C……………………………………………….(3.2)
+��ℎ ℎ�����*A,C =∝ +EF����1A,C + EG+HIA,CJF + EK L��MA,C + EN �O+A,C
+EP���A,C + EQ�;A,C + ER�ℎ����ℎA,C ∗ +HIA,CJF + ET�ℎ����ℎA,C + EU����;���A,C +EFVW�;A,C + EFF���=A,C + �A,C……………………………………………….(3.3)
+HIA,CJF = Corporate governance index of firm “i” at time t-1
L��MA,C= market to book ratio of firm “i” at time t
�O+A,C= net working capital of firm “i” at time t
X��A,C= size of firm “i” at time t
Y;A,C= leverage of firm “i” at time t
S+A,C= product market competition dummy of firm “i” at time t
Z� ���A,C= family ownership dummy of firm “i” at time t
Xℎ����ℎA,C= Shariah compliance dummy 1 for Shariah compliance and 0 for non-Shariah
compliance of firm “i” at time t
W�;A,C=dividend dummy of firm “i” at time t
+��=A,C= capital expenditure of firm “i” at time t
91
3.5 Value of Cash holding
This research follows the work of Faulkender and Wang (2006); Dittmar and Mahrt-
Smith (2007) to investigate the effect of corporate governance on value of cash holding.
Furthermore, to investigate effect of corporate governance on value of cash holding in
competitive and concentrated industries; family and non-family firms; Shariah and non-
Shariah compliant firms. The research basically investigated that whether firm value
changes due to changes in cash holding. The change occurred in value of firm is measured
through excess return and calculated as return of firm “i “during year t minus bench mark
portfolio return to which stock “i ” belongs during year. The portfolio of bench mark is 25
Fama and French portfolios created on basis of size and book-to-market ratio. This research
basically measure value of firm with respect to change in value of firm due to change in
cash. The dependent variable is excess return and main independent variable is change in
cash to which lag cash, market leverage and governance is interacted and independent
variables is divided by lag market value of equity. The division of independent variables by
lag market value of equity enable researcher that the coefficient of change in cash is
interpreted in a way that one extra Pakistani rupee result how much change in wealth of
shareholders. To determine the effect of good governance on excess return, governance
dummy 1 for good governance and 0 for poor governance is interacted with change in cash
scale by lag market value and regressed on excess return. This research expects that
interaction of good governance and change in cash to market value shows positive effect on
excess return. The researcher may expect that holding of extra Pakistani rupee will increase
value of firm in the presence of good governance. The expected coefficient of interaction
between good governance dummy and change in cash shows the change in firm value
through cash in presence of good governance. The regression of value regression shows
marginal change.
92
[A,C − [MA,C =∝ +EF⊿+\A,CL]A,CJF
+ EG+HIA,C + EK+HIA,C ∗ ⊿+\A,CL]A,CJF
+ ENI;A,C + EP⊿^�����*A,C
L]A,CJF
+ EQ⊿W�;�����A,C
L]A,CJF+ ERY;A,C ∗ ⊿+\A,C
L]A,CJF+ ET
⊿��_���A,CL]CJF
+ EU+\A,CJFL]A,CJF
∗ ⊿+\A,CL]CJF
+ EFV⊿IA,C
L]CJF+ EFF
+\A,CJFL]CJF
+ EFG⊿��_���A,C
L]CJF+ +ƲA,C
[A,C − [MA,C =∝ +EF⊿abc,d
efc,dgh+ EG��;�A,C + EK��;�A,C ∗ ⊿abc,d
efc,dgh+ ENI;A,C +
EP⊿ijklAlmc,d
efc,dgh+ EQ
⊿nAoApqlprc,defc,dgh
+ ERY;A,C ∗ ⊿abc,defc,dgh
+ ET⊿sqCtrrqCc,d
efdgh+
EUabc,dghefc,dgh
∗ ⊿abc,defdgh
+ EFV⊿uc,d
efdgh+ EFF
abc,dghefdgh
+ EFG⊿sqCtrrqCc,d
efdgh+ ƲA,C………(3.5)
⊿X shows change in control variables form t-1 to t. [A,C indicates stock return of
company i from t-1 to t. [MA,CFama and French (1993) size and book-to-market matched
portfolio return from year t-1 to t. L]A,CJF shows the lag market value of equity and ⊿+\A,C
shows change in cash from t-1 to t, where ⊿^�����*A,C shows change in earning from t-1 to
t and measured as earning before extra-ordinary items. ⊿W�;����� show change in
dividend from t-1 to t and I; shows market leverage which is measured as total debt
divide by total debt plus market value of equity at time t. +\A,CJF shows cash at time t-1 and
⊿��_���A,C shows change in net asset from t-1 to t and is measured as total asset minus
cash. CGI which is main variable of interest shows corporate governance dummy and
measured by dividing corporate governance index in three terciles 1 for firms that lies in
highest tercile at particular year and 0 for firms that lies in middle and lowest tercile at
particular year. Diver shows corporate diversification which is measured through dummy
variable with 1 for diversified firms and 0 for stand-alone firms. For the effect of corporate
diversification on value of cash holding the same control variables is used as it is used in
effect of corporate governance and value of cash holding relationship. The reason is that it is
93
the most common variables used by various researchers as determining value of cash
holding (e.g., Faulkender& Wang, 2006; Dittmar & Mahrt-Smith, 2007; Tong, 2011; Jain et
al., 2013; Alimov, 2014). Furthermore, the objective of research is to investigate whether
corporate diversification add firm value through cash?
3.6 Analytical model for spending excess cash
The research shows that value of firm increases through efficient utilization of
excess cash and good governance effect efficient utilization of excess cash. This research
considers three way of utilization of excess cash i-e industry adjusted capital expenditure;
dividend and diversification.
⊿���+��=A,C =∝ +EF^=��A,CJF + EGH�;A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C +EP L��MA,C+EQ���A,C + ER�;A,C + +ET����1A,C + EU����;A,C + �A,C………(3.6)
W�;A,C =∝ +EF^=��A,CJF + EGHv]A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C +EP L��MA,C+EQ���A,C + ER�;A,C + +ET����1A,C + EU����;A,C + �A,C…………(3.7)
W�;�A,C =∝ +EF^=��A,CJF + EGH�;A,CJF + EK^=��CJF ∗ H�;A,CJF + EN�O+A,C + EP L��MA,C+EQ���A,C + ER�;A,C + +ET����1A,C + EU����;A,C+ �A,C … … . (3.8)
⊿�����}+��=A,C shows the change in industry adjusted capital expenditure from year t-1 to
t that is measured as median of capital expenditure calculated for the particular year and
subtracted from the firm capital expenditure for that year.
W�;A,C shows firm dividend 1 for dividend paying firm and zero non-paying dividend firm
Diveri,t is corporate diversification of firm i at time t.
^=��A,CJF represents excess cash which is calculated as residual of (Opler et al., 1999)
equation which is given in appendix1.
94
Hv]A,CJF represent governance dummy 1 for good governance and 0 for poor governance
and
L��MA,C shows market to book ratio.
�;A,C is leverage ratio
����1A,C is the cash flow of the firm i at time t
����;A,C industry adjusted volatility of firm i at time t.
3.7 Analytical model for governance and total factor productivity growth
To analyze that excess cash under good governance increases total factor
productivity growth. Total factor productivity growth is used to measure the performance of
the company.
�ZSHA,C =∝ +EF^=��� ���ℎA,CJF + EG*�;A,CJF + EK����1A,CJF + EN�O+A,CJF + EP L��MCJF+EQ���CJF + ER�;CJF + ET^=��� ���ℎCJF ∗ *�;CJF+ EU����;A,CJF + EFV���=A,CJF + �A,C … … … … … (3.9)
3.7.1 Total Factor Productivity Growth
Fare et al (1994) proposed Malmquist index which measures total factor productivity change
between two time periods.
VC (1r, =r, 1C, =C) = p�d (�d�d)p�d (�d�d)
The symbol s is the point for reference technology while t point shows base technology.
Collie et al (2005) remove the restriction in selection of one technology in these two
technology malmquist index for total factor productivity become as
�(1r, =r, 1C , =C) = �p�� (�d,�d)p�� (��,��) × p�d (�d,�d)
p�d (��,��)
95
The value of � greater than 1 indicates positive total factor productivity growth.
And value of � less than 1 indicates deteriorating total factor productivity. This means
that either positive growth occurs between base period and reference period or it become
more worst
Tfpch= Effch× Tch
This refers that there are two sources of total factor productivity change including
efficiency change and technological change therefore; it is constant return to scale.
Furthermore, for more insight into the sources of efficiency change we impose variable
return to scale assumption. According to this assumption efficiency change is further
decomposed into pure efficiency change and scale efficiency change. The pure efficiency
change is as follow.
PTECH = p��d (�d,�d)p��� ���,���
The scale efficiency change is as follow.
SECH = �p��d (�d,�d)/p��d (�d,�d)p��d (��,��)/p��d (��,��) × p��� (�d,�d)/p��d (�d,�d)
p��� (��,��)/p��� (��,��)�F/G
Scale efficiency change refers to the geometric mean between the two periods scale
efficiency i.e., change period’s s and t. The symbol “v” and “c” shows two basic
assumptions i.e., constant return to scale and variable return to scale. The value of scale
efficiency greater than 1 indicates positive efficiency change and value less than 1 indicates
deteriorating behavior. In the same way the value of pure technical efficiency change greater
than 1 shows a positive change in technical efficiency, while less than 1 indicates
deteriorating behavior.
96
3.7.2 Input and Output for total factor productivity growth
The dissertation used the output and inputs following Feroz, Kim, and Raab (2003);
Raheman, Afza, Qayyum, and Bodla (2008).They used sales revenue as output and total
assets, cost of goods sold, shareholder expenses and shareholders’ equity as inputs.
97
CHAPTER 4
RESULT AND DISCUSSION
This chapter presents the findings and discussions of the study. The effect of
corporate governance on level of cash holding and value of cash holding is discussed in
section 4.1 and 4.2 respectively and how this relationship vary cross different settings
including product market competition, family ownership and Shariah compliance. In the
section 4.3 the role of corporate governance on utilization of excess cash is discussed.
Moreover, their relationship is investigated in competitive and concentrated industries;
family and non-family firms; Shariah and non-Shariah compliant firms. The three ways of
utilization excess cash is considered i.e., industry adjusted in capital expenditure, dividend
and diversification. In section 4.4 the role of corporate governance on excess cash and firm
performance is discussed in competitive and concentrated industries; family and non-family
firms; Shariah and non-Shariah compliant firms is discussed. Finally, the effect of corporate
diversification on value of cash holding is discussed in section 4.5 in the context of well
governed and poorly governed firms; competitive and concentrated industries; family and
non-family firms; Shariah and non-Shariah compliant firms
4.1 Effect of corporate governance on Cash holding
This section presents the results corresponding to objective 1 and sub-objectives 1a,
1b, 1c. Table 4.1 presents descriptive statistics of the data used for this purpose
98
Table 4. 1: Descriptive Statistics
Variable Fullsample Comp Conc Shariah Nonshariah Family Nonfamily
Cash 0.054 0.041 0.078 0.067 0.042 0.048 0.071
(0.115) (0.095) (0.142) (0.123) (0.106) (0.120) (0.100)
CFLOW 0.095 0.088 0.107 0.106 0.083 0.088 0.112
(0.112) (0.102) (0.127) (0.101) (0.121) (0.108) (0.121)
INDCV 0.010 0.012 0.008 0.008 0.013 0.009 0.014
(0.051) (0.053) (0.046) (0.038) (0.061) (0.052) (0.049)
Lev 0.552 0.555 0.546 0.365 0.583 0.556 0.540
(0.201) (0.198) (0.207) (0.188) (0.209) (0.190) (0.229)
NWC 0.039 0.031 0.053 0.056 0.022 0.024 0.080
(0.218) (0.210) (0.233) (0.201) (0.233) (0.199) (0.259)
Div 0.588 0.556 0.646 0.620 0.557 0.570 0.637
(0.492) (0.497) (0.479) (0.486) (0.497) (0.495) (0.482)
Govindex 0.453 0.465 0.431 0.439 0.467 0.466 0.417
(0.198) (0.202) (0.191) (0.206) (0.189) (0.193) (0.208)
Size 15.465 15.127 16.084 15.750 15.185 15.278 15.972
(1.491) (1.252) (1.686) (1.529) (1.397) (1.352) (1.716)
MtoB 0.066 -0.001 0.188 0.092 0.039 -0.026 0.313
(0.606) (0.602) (0.595) (0.528) (0.672) (0.494) (0.785)
CAPEX 0.064 0.058 0.074 0.066 0.061 0.062 0.068
(0.045) (0.025) (0.067) (0.051) (0.039) (0.040) (0.057)
First term is mean and second term in bracket is standard deviation. The second column shows
descriptive statistics for full sample. Third column represents firms belonging to competitive industries
which are measure through HHI lowest tercile is competitive industry and middle and highest tercile is
concentrated industries. Fourth column shows firms belonging to concentrated industries; fourth column
shows Shariah compliant firms. Fifth column shows non-Shariah compliant firms. Sixth column shows
family firms and seventh column shows non-family firms. cflow stands for cash flow, indcv stands for
industry adjusted cash flow volatility, lev stands for leverage, nwc stands for net working capital, div
stands for dividend 1 for dividing paying firm at particular year and 0 for non-paying dividend forms at
particular year. Size stands for size of firm, mtob stands for market to book ratio and capex stands for
capital expenditure
Table 4.1 shows descriptive statistics of all variables. The first term in each cell is
mean while the second term in bracket is standard deviation. Second column shows full
sample, third column shows firms belonging to competitive industries which are measure
99
through HHI lowest tercile is competitive industry, while middle and highest tercile is
concentrated industries. Fourth column shows firms belonging to concentrated industries;
fifth column shows Shariah compliant firms, sixth column shows non-Shariah compliant
firms, seventh column shows family firms and eighth column shows non-family firms.
Cash holding which is measure cash divide by net asset.
The descriptive statistics indicate that companies hold less cash in competitive
industries compared to firms in concentrated industries. Moreover, firms from competitive
industries have less leverage, networking capital, size, dividend and capital expenditure
compared to the firms belonging from concentrated industries. Furthermore, the descriptive
statistics also shows mean and standard deviation values of variables between family owned
firms and non- family owned firms. The result shows that family owned companies have
comparatively lower cash, cash flow and industry adjusted cash flow volatility, market to
book ratio and capital expenditure than non-family firms. Moreover, they have high
leverage, networking capital and good governance score compare to non-family firms. Table
4.1 also shows descriptive statistics of variables in Shariah compliant firms and non-
Shariah compliant firms. The result shows that Shariah compliant firms have high cash
holding, high cash flow and high dividend, market to book ratio and governance index
compared to non- Shariah compliant firms. The result also shows that Shariah compliant
firms have low leverage, networking capital compared to non Shariah compliant firms,
while capital expenditure is not different in the Shariah and non- Shariah compliant firms.
Table 4.2 shows effect of corporate governance on cash holding and the role of
product market competition, concentration, family ownership and Shariah compliance
respectively in the corporate governance and cash holding relationship. Table 4.2 reports
results of five models. Dependent variable for each model is corporate cash holding which is
measured as cash holding divide by net asset. The purpose of each model is as follows:
100
Model 1 shows effect of corporate governance index on cash holding. Model 2
shows role of product market competition in the relationship of corporate governance and
cash holding. Product market competition is measured through HHI index which is divided
in tercile the lowest tercile is assigned 1 which measured competition and other wise 0.
Model 3 shows effect of concentration on corporate governance and cash holding
relationship. Concentration is the highest and middle tercile which is assigned 1 otherwise 0.
Model 4 shows role of corporate governance on cash holding in family and non-family
firms. Family ownership is measured through dummy variable 1 for family firms and 0 for
non-family firms. Model 5 shows role of Shariah compliance in corporate governance and
cash holding relationship. Shariah compliance is measured through a dummy variable with
1 for Shariah compliant firms and 0 for non-Shariah compliant firms.
Each model has eight controlled variables including: cash flow (cflow) , industry
adjusted cash flow volatility (indcv), market to book ratio (mtob), size of the firm (size),
leverage of the firm (lev), net working capital (nwc), capital expenditure (capex) and
dividend (div). All models data is winsorized at 1% and 99%.
All tables are created on APA style and also format of tables is adopted from
(Harford et al., 2008, Jain et al., 2013; Uddin, 2016; Ullah & Kamal, 2017).
Table 4.2: Effect of corporate governance on cash holding (Dependent variable: Cash holding)
Cash model1 model2 model3 model4 model5
Govind -0.325 *** 0.162
-0.361 ** 0.034
-0.196 **
(0.089) (0.151)
(0.157)
(0.186)
(0.091)
Comp
0.168 *
(0.098)
comp*govind -0.523 ***
(0.178)
Conc
-0.168
(0.108)
conc*govind 0.523 **
(0.254)
Family
-0.046
(0.042)
101
family*govind -0.368 *
(0.208)
Shariah
0.085
(0.109)
sharia*govind -0.107
(0.214)
Cflow 0.908 *** 0.986 *** 0.986 *** 0.893 *** 0.998 ***
(0.238) (0.225)
(0.304)
(0.221)
(0.234)
Indcv 0.926 0.653
0.653
0.657 ** 0.670
(0.439) (0.399)
(0.591)
(0.420)
(0.410)
MtoB 0.380 *** 0.239 *** 0.239 *** 0.241 *** 0.232 ***
(0.036) (0.041)
(0.071)
(0.044)
(0.044)
Size 0.015 -0.013
-0.013
-0.016
-0.013 **
(0.012) (0.015)
(0.029)
(0.016)
(0.016)
Lev -0.964 *** -0.901 *** -0.901 *** -0.908 *** -0.887 ***
(0.118) (0.118)
(0.219)
(0.127)
(0.127)
Nwc -0.405 *** -0.422 *** -0.422 ** -0.434 *** -0.410 ***
(0.111) (0.104)
(0.178)
(0.107)
(0.107)
Capex -0.327 * -0.280
-0.280
-0.269
-0.278
(0.187) (0.171)
(0.177)
(0.174)
(0.175)
Div 0.151 *** 0.111 *** 0.111 ** 0.113 *** 0.109 ***
(0.045) (0.042)
(0.055)
(0.041)
(0.041)
Cons -1.586 *** -0.770 ***
-0.561 ** -0.670 **
(0.207) (0.275)
(0.268)
(0.273)
R2 0.268 0.428
0.428
0.425
0.424
F-
pvalue 0.000
0.000
0.000
0.000
0.000
Dependent variable is corporate cash holding. Model 1 shows effect of corporate governance index on cash
holding, model 2 shows role of product market competition in the relationship of corporate governance and
cash holding. Model 3 shows effect of concentration on corporate governance and cash holding relationship.
Model 4 shows role of corporate governance on cash holding in family and non-family firms. Model 5 shows
role of Shariah compliance in corporate governance and cash holding relationship. All models are run with
time dummies, industry fixed effect, and standard error cluster with firm effect. First term in each cell shows
coefficient of variables and term in bracket shows standard error*, **, *** shows significance at 10%,5% and
1% respectively
.
The following subsections (4.1.1-4.1.5) discuss results of the five models presented in Table
4.2.
4.1.1 Corporate governance and Cash holding
The second column of Table 4.2 (i.e., Model 1) shows effect of corporate
governance score on level of cash holding and shows negative relationship of corporate
102
governance with cash holding. The result is interpreted as firms with good corporate
governance hold less cash. The result is supported by agency theory (Jensen, 1986) which
holds that high cash is expropriate by entrenched managers for their private benefit.
Therefore, agency problem leads to high level of cash and spending high cash on value
decreasing investments. The agency problem can be resolved through proper governance
which leads to low level of cash holding (Jensen, 1986). Moreover, negative effect of
corporate governance on cash holding is also supported by flexibility hypothesis. The
hypothesis claim that agency problem has positive relationship with cash holding because
high entrenched managers hold high cash to derive private benefit on the cost of minority
shareholders and tend to avoid external monitoring.
The empirical literature shows mixed result for relationship between firm level of
corporate governance and cash holding. For example, Harford et al. (2008) found that
corporate governance posits strong positive effect on cash holding. Similarly, Haung et al.,
(2013) used international data and found that high investor protection leads to high level of
cash holding. On the other hand, Kalcheva and Lins (2007) found insignificant effect of
corporate governance on cash holding. Our results are in line with Dittmar et al. (2003) who
used international data and found that companies hold less cash where investor protection is
weak as compared to the countries where investor protection is high. Our result is also
supported by Amman et al. (2011); Ozkan and Ozkan (2004); Kusnadi (2011) that firm level
corporate governance posits negative relationship with corporate cash holding. Keeping in
view the above results, H1a research hypothesis is accepted that corporate governance has
significant effect on corporate cash holding.
The control variables for model 1 have same predicted sign as expected. In line with
Harford et al. (2008) the result shows that cash flow and industry adjusted cash flow
volatility have positive and significant effect on cash holding. Furthermore, result of
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dissertation shows that growth opportunity measured by market to book ratio has positive
significant relationship with level of cash holding and the result is supported by (Harford et
al., 2008; Cheng & Chaung, 2009; Kuan et al., 2011). The result indicates that firms that
having high growth opportunity hold high level of cash. Moreover, results indicate that
leverage is substitute to cash since it has negative relation with cash holding. The result is
supported by hierarchy theory that cash and leverage is substitute to each other and leverage
exerts negative effect on corporate cash holding. Similarly, net working capital and capital
expenditure also have negative relationship with cash holding as suggested by previous
studies (See for example, Cheng & Chaung, 2009; Harford et al., 2008; Kuan et al., 2011).
Furthermore, dividend has positive relationship with level of cash holding and indicates that
dividend paying companies hold high level of cash. These results are in line with Chieh-Tsai
(2012) who also shows positive relationship of dividend with corporate cash holding. The
value of R2 is 26.8%, means that cash holding is explained due to independent variables up
to 26.8%.
4.1.2 Effect of product market competition on the corporate governance and cash
holding relationship
The third column of Table 4.2 (i.e., Model 2) shows the effect of product market
competition on the relationship of corporate governance and cash holding. The result shows
that interaction of corporate governance index and competition dummy have negative and
significant effect on corporate cash holding. The result is supported by agency theory
(Jensen, 1986) that corporate governance has negative effect on corporate cash holding in
competitive industries. Firms operating in competitive industries and have good corporate
governance hold 0.523 less cash compare to firms operating in concentrated industries. In
line with Jain et al. (2013), result shows that firm level corporate governance exerts negative
effect on corporate cash in competitive industries compare to concentrated industries.
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Moreover, one of the queries of current research is to check whether corporate
governance has substitution effect for corporate governance in relationship with cash
holding. The result suggest that product market competition has substitution effect for
corporate governance in relationship with cash holding because sign of main variables i-e,
product market competition and corporate governance index is different from sign of
interaction term. Shen, Leng, and Wang (2015); Pattanayak (2010) suggests that if the sign
of main variables and interaction term is different it assumes substitution effect argument.
Substitution effect argument claims that product market competition work as
external market discipline which discourages managers to expropriate free cash flows for
their own interest even firm level governance is weak (Amman et al., 2013). External
market discipline put pressure on managers to work in best interest of shareholders even
firm level governance is weak compare to firms that are operating in concentrated industries
(Holmstrom, 1982; Nalebuff & Stiglitz, 1983; Hart, 1983; Giroud & Mueller, 2010;
Guadalupe & Perez-Gonzalez, 2010; Jain et al., 2013). Moreover, corporate governance is
more concerned in industries where competition is low because lack of external market
discipline to mitigate agency problem (Bena et al., 2017).
The researchers also show that strategic benefit of holding high cash exist in
concentrated industries compared to competitive industries because in concentrated
industries firms face difficulty to raise funds in capital market (Haushalter et al., 2007).
Moreover, in concentrated industries low cash may raise chance of under investment.
However, external market discipline is weak in concentrated industries and strong corporate
governance is needed to minimize the concern of shareholders about high cash holding in
concentrated industries (Jain et al., 2013). On the other hand, in competitive industries firms
have problem of over-investment because they make investment against their rivals and use
internal funds to create barriers for new entrants in the market. In competitive industry firms
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have shorter product life cycle and shareholders prefer low cash due to chance of over-
investment.
The relationship between corporate governance and cash holding in competitive
industries is also supported by flexibility hypothesis (Jensen, 1986) that corporate
governance has negative relationship with corporate cash holding in competitive industries.
On the basis of above discussion result of dissertation supported H1b hypothesis that
product market competition has substitution effect for corporate governance in relationship
with cash holding is accepted. The interaction of corporate governance index and product
market competition dummy is significant. The interaction term sign and the sign of main
variables i-e., corporate governance index and product market competition is different
which support substitution effect argument.
4.1.3 The effect of concentration on corporate governance and cash holding
relationship
The result of fourth column of table 4.2 (Model 3) shows the effect of corporate
governance on cash holding in concentrated industry. Governance index has positive but
insignificant effect on cash holding compared to model 1. The reason is that once interaction
term is included in regression the interpretation of main variables is different compared to
main variable used without interaction. Here the corporate governance index shows the
effect of omitted group that is competitive industry which takes value of zero and firms
belong to concentrated industries at particular year takes value of one. The interaction term
of corporate governance index and concentration shows positive relationship by 0.523. The
result indicates that difference between slope of governance index in concentrated industry
and slope of governance index in competitive industry. In line with Jain et al. (2013) the
result shows that in concentrated industry firms hold more cash as compare to firms in
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competitive industries. In concentrated industries the relationship between corporate
governance and cash holding is supported by spending hypothesis, that corporate
governance posits positive relationship with cash holding. The control variables including
market to book ratio, size, leverage, networking capital, capital expenditure, cash flow, cash
flow volatility and dividend are used on the precautionary motive of cash inspired from the
work of Opler et al. (1999); Harford et al. (2008); Jain et al. (2013). The control variables
have same sign as predicted and have same magnitude and significance level as model1 of
model 2 discussed in the preceding section (4.2.1).
4.1.4 Effect of corporate governance on cash holding in family and non-family firms
The result of column 5 of table 4.2 (Model 4) shows the effect of corporate
governance on cash holding in family firms using interaction term of governance index and
family firms dummy value of one for family firms and 0 for non-family firms. The essence
of this model is to investigate the effect of corporate governance on cash holding in family
owned firms because family owned firms have their unique organization structure compare
to non- family firms. The result shows that corporate governance has negative and
significant effect on cash holding in family firms. The result is supported in the context of
agency theory (Jensen, 1986) that family owned firms want to transfer their businesses from
one generation to another generation and want to make empire building for their family and
prefer high cash holding. Due to agency problem family owned firms are usually involved in
value destroying investment on the cost of minority investors (Kuan et al., 2011). In line
with these arguments, corporate governance shows negative relationship with cash holding
in family firms and limited the power of controlling shareholders.
Kalcheva and Lins (2007) found when investor protection are low, firms hold more
cash and interaction of percentage of managerial control and shareholder protection posits
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insignificant effect on cash holding using international data. The result of this dissertation
shows that corporate governance exerts negative effect on cash holding in family firms. The
result shows that family owned firms in Pakistan holds less cash by 0.346 when corporate
governance is improved in family owned firm as compared to non- family firm. Our result
are in line with Kuan et al. (2011) who also found negative effect of corporate governance
on cash holding in family owned firms.
The result is also supported by flexibility hypothesis (Jensen, 1986) that due to
agency problem family owned firms prefer high cash to expropriate for serving family
interest on empire building and value destroying over-investments on cost of minority
interest. Therefore, under good corporate governance shareholder prefer less cash in family
owned firms. In Pakistan Sheikh and khan (2015) found negative relation of board attributes
with corporate cash holding in family firms. Keeping in view these findings our research
hypothesis H1c is accepted that corporate governance has significant effect on cash holding
in family firms
The control variables including cash flow, cash flow volatility, leverage, networking
capital, capital expenditure and market to book ratio have same sign and significance level
as in column one and column two. The controlled variables sign is supported by
precautionary motive of cash.
4.1.5 The effect of corporate governance on cash holding in Shariah compliant firms
The last column (Model 5) of table 4.2 shows the effect of corporate governance on
cash holding in Shariah compliant firms. Shariah compliant firms have unique
organizational structure compared to non-Shariah compliant firms. Shariah compliant firms
must fulfill certain requirements to be considered as Shariah compliant firms’ i-e holding
liquid assets up to maximum 33%, holding debts up to maximum 37%, Investment only in
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halal businesses etc. The effect of corporate governance on cash holding in Shariah
compliant firms is explained in the context of agency theory. Shariah compliance resolve
agency problem due to its organization structure and substitute to corporate governance.
The result shows that effect of corporate governance on cash holding in Shariah
compliant firms is insignificant. The result is in line with Hayat and Hassan, (2017) found
that Shariah compliance does not promote corporate governance.
The result of this dissertation rejected hypotheses H1d that Shariah Compliance has
substitution effect for corporate governance in relationship with cash holding.
The control variables including cash flow, industry adjusted cash flow volatility,
leverage, networking capital, market to book ratio and industry adjusted capital expenditure
have the effect on corporate cash holding as per the prediction of precautionary cash motive
theory and have same sign and magnitude as model1.
4.1.6 Control of Endogeneity
This research found negative relationship of corporate governance and cash holding.
The simple OLS may be biased on the basis that normally corporate governance and cash
holding is jointly determined (Harford et al., 2008). To control endogeneity, 2SLS is
suggested in the literature. However, the problem is that 2SLS needs valid instrumental
variable but literature is normally silent about proper instrumental variables in corporate
governance and cash holding relationship (Harford et al., 2008). Therefore, to overcome this
problem, system GMM has been used to control endogeneity problem. The advantage of
system GMM is that it considers lag of dependent and independent variables as instrumental
variables. Therefore, there is no need to provide specific instrumental variables.
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Family ownership is endogenous choice between corporate governance and cash
holding. Family ownership is choice of corporate governance whereas, family ownership
and cash holding is jointly determined (Kuan et al., 2011). Furthermore, product market
competition is endogenous choice of corporate governance because competition is external
market discipline which acts as substitute for corporate governance. To control this problem
GMM model has been used. In the same way we also used GMM model to check the
relationship of corporate governance and cash holding in Shariah compliant firms.
Table 4.3 shows dynamic panel model for controlling endogeneity in the relationship
of corporate governance and cash holding. Furthermore, the role of product market
competition, family ownership and Shariah compliance is checked in the relationship of
corporate governance and cash holding. Model 1 shows effect of corporate governance
index on cash holding, model 2 shows role of product market competition in relationship of
corporate governance and cash holding. Product market competition is measured through
HHI index which is divided in tercile. The lowest tercile is assigned 1 which measured
competition and other wise 0. Model 3 shows role of corporate governance on cash holding
in family firms. Family ownership is measured through dummy variable with 1 for family
firms and 0 for non-family firms. Model 4 shows role of Shariah compliance on corporate
governance and cash holding relationship, which is measured as 1 for Shariah compliant
firms and 0 for non-Shariah compliant firms. Dependent variable is corporate cash holding
which is measured as ratio of cash holding to net asset. Each model has eight control
variables including: cash flow (cflow) , industry adjusted cash flow volatility (indcv),
market to book ratio (mtob), size of the firm (size), leverage of the firm (lev), net working
capital (nwc), capital expenditure (capex) and dividend (div).
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Table 4.3: Dynamic panel model GMM effect of corporate governance on cash holding
model1 model2 model3 model4
casht-1 0.153 ** 0.154 ** 0.161 ** 0.157 **
(0.069) (0.069) (0.071) (0.070)
govind -0.186 * 0.145 -0.338 * -0.080
(0.106) (0.130) (0.173) (0.106)
comp*govind -0.383 **
(0.167)
comp
0.145 **
(0.067)
family
-0.467
(0.509)
family*govind
0.396 *
(0.210)
shariah
-0.038
(0.077)
shariah*govind
0.149
(0.180)
cflow 0.997 *** 1.009 *** 1.027 *** 0.999 ***
(0.244) (0.245) (0.248) (0.243)
indcv 0.180 *** 0.262 0.223 0.190
(0.047) (0.589) (0.589) (0.590)
mtob 0.180 *** 0.188 *** 0.172 *** 0.179 ***
(0.047) (0.046) (0.046) (0.047)
size 0.212 0.092 0.095 0.110 *
(0.588) (0.061) (0.061) (0.059)
lev -1.051 *** -0.990 *** -1.019 *** -1.048 ***
(0.263) (0.253) (0.262) (0.262)
nwc -1.092 *** -1.098 *** -1.101 *** -1.095 ***
(0.210) (0.211) (0.211) (0.209)
capex -0.388 *** -0.413 *** -0.396 *** -0.390 ***
(0.130) (0.132) (0.132) (0.130)
div -0.047 -0.039 -0.048 -0.050
(0.044) (0.043) (0.045) (0.044)
constant -2.691 *** -2.523 *** -2.123 *** -2.683 ***
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(0.929) (0.969) (1.112) (0.924)
wald chi2 0.000 0.000 0.000 0.000
AR2 p- value 0.172 0.845 0.945 0.988
Sargen p-chi2 0.770 0.095 0.102 0.129
Model 1 shows effect of corporate governance index on cash holding, while model 2 shows role of product
market competition on relationship of corporate governance and cash holding. Model 3 shows role of
corporate governance on cash holding in family and non-family firms. Model 4 shows role of Shariah
compliance on corporate governance and cash holding relationship. Dependent variable for each model is
corporate cash holding. Control variables include cflow (cash flow) , indcv (industry adjusted cash flow
volatility), mtob (market to book ratio), size, lev (leverage), nwc (net working capital), capex (capital
expenditure) and div (dividend). All models are run with time dummies and industry fixed effect and standard
error cluster with firm effect. *, **, *** shows significance at 10%,5% and 1%. First term shows coefficient of
variables and term in bracket shows standard error.
Table 4.3 shows the result of relationship between corporate governance index and
cash holding using system GMM and shows almost same result as table 4.2. Model 1 of
table 4.3 shows that corporate governance index have negative significant relationship with
corporate cash holding which is same as the result of corporate governance and cash holding
relationship of model 1 in table 4.2. The only difference is that corporate governance and
cash holding relationship is significant at 10% confidence level in table 4.3 compared to
table 4.2 where the relationship of corporate governance index and cash holding is
significant at 1%. However, the coefficient of corporate governance index is low in table 4.3
compared to table 4.2. Similarly, all control variables have almost same direction and
significance level. Furthermore, lagged cash holding is significant at 5% which indicates
that past cash holding predicted future cash holding.
The difference in the result of table 4.3 and table 4.2 is that industry adjusted cash
flow volatility is positive and significant in table 4.3, while it is insignificant in table 4.2.
The result of Wald test shows that overall model is significant at 1% confidence interval.
The result of Sargan test is insignificant which counts against the null hypothesis that there
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is no over identification problem. The result of AR2 is also insignificant and shows the auto
correlation is mitigated at lag 2.
The result of column 3 (Model 2) of table 4.3 shows the result of relationship
between corporate governance and cash holding in competitive industry using system
GMM. The result of interaction term of corporate governance index and product market
competition dummy posits negative relationship with cash holding that is similar to the
previous result in table 4.2. All control variables like cash flow, cash flow volatility,
leverage, networking capital, market to book ratio and capital expenditure have same sign
except dividend. Dividend has positive relationship with cash holding in table 4.2, while it
has negative relationship with cash holding in Table 4.3. This indicates that as dividend
increases firms hold less cash because when firm hoard high cash than mangers prefer to
utilize cash in form of dividend (Opler et al., 1999).
The result of column 4 (Model 3) of table 4.3 shows the effect of family ownership
on corporate governance and cash holding relationship using system GMM. The interaction
of family ownership and corporate governance posits different result between OLS and
system GMM. The table 4.2 indicates negative effect of corporate governance interaction
with family dummy on cash holding. On the contrary, the system GMM (table 4.3) indicates
that the interaction of corporate governance index and family ownership has positive
relationship with cash holding. The results of model 3 in GMM model are supported by
spending hypothesis and shareholder power hypothesis.
According to spending hypothesis firms utilize less cash in value destruction
investment under good governance and hoard high cash (Harford et al., 2008). Share holder
power hypothesis claims that minority investors allow firm to hold high cash as corporate
governance improves because they do not worry about firms to destroy free cash due to
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agency problem. Moreover, high cash will safeguard firm from under investment when firm
hold high cash. Similarly, according to share holder power hypothesis minority investors
willingly allow managers to hoard high cash when corporate governance is good. The result
is also in line with the work of Sheikh and khan (2015). Similarly, the result of lag cash
holding is positive and significant which indicates that past cash predict future cash holding.
Moreover, all controlled variables have same sign as presented in table 4.2.
Model four of table 4.3 shows the moderating role of Shariah compliance in the
relationship of corporate governance and cash holding using system GMM. The result is
same as table 4.2. The result shows that corporate governance index and Shariah
compliance interaction has insignificant relationship with corporate cash holding. Similarly,
all control variables have the same sign as in table 4.2 but the significance level is different.
4.2 Effect of corporate governance on Value of Cash holding
This section presents the results corresponding to objective 2 and sub-objectives 2a,
2b, 2c. Table 4.4 presents descriptive statistics of the data used for this purpose.
Table 4.4: Descriptive Statistics
full comp conc family
N-
family shariah
N-
shariah
ER -0.020 0.013 -0.079 0.011 -0.069 -0.007 -0.028
(0.491) (0.520) (0.429) (0.519) (0.440) (0.454) (0.513)
⊿CH 0.025 0.037 0.003 0.017 0.038 0.046 0.012
(0.425) (0.487) (0.281) (0.266) (0.599) (0.607) (0.253)
⊿Earning 0.035 0.064 -0.020 0.102 -0.074 -0.090 0.112
(6.375) (7.936) (0.816) (1.664) (10.111) (10.105) (1.612)
⊿NA 1.477 2.078 0.402 0.717 2.710 2.722 0.705
(18.088) (22.527) (1.622) (4.324) (28.747) (28.695) (4.315)
⊿INT 0.029 0.041 0.008 -0.014 0.098 0.086 -0.006
(1.097) (1.363) (0.163) (0.391) (1.704) (1.711) (0.364)
114
⊿D -0.007 -0.013 0.003 0.011 -0.037 -0.030 0.006
(1.805) (2.245) (0.255) (0.201) (2.913) (2.908) (0.199)
CHt-1 0.177 0.165 0.198 0.175 0.180 0.200 0.162
(0.423) (0.427) (0.417) (0.404) (0.454) (0.514) (0.353)
CHt-1*⊿CH -0.007 -0.002 -0.017 -0.017 0.008 0.006 -0.015
(0.669) (0.719) (0.571) (0.459) (0.911) (0.902) (0.459)
mktlev 0.602 0.643 0.528 0.663 0.503 0.336 0.649
(0.271) (0.266) (0.264) (0.246) (0.279) (0.262) (0.265)
mktlev*⊿CH 0.021 0.032 0.001 0.013 0.035 0.040 0.009
(0.406) (0.476) (0.230) (0.236) (0.584) (0.591) (0.224)
gov*⊿CH 0.000 0.001 -0.001 0.000 0.001 0.002 -0.001
(0.182) (0.164) (0.211) (0.196) (0.158) (0.172) (0.188)
gov 0.287 0.313 0.242 0.328 0.223 0.258 0.305
(0.453) (0.464) (0.429) (0.470) (0.417) (0.438) (0.461)
Second column shows descriptive statistics for full sample, column third shows competitive
industries, while column four shows concentrated industries. Column fifth shows family firms,
while column sixth shows non-family firms. Column seven shows Shariah compliant firms and
column eight shows non-Shariah compliant firms. ER shows excess return, ⊿CH shows change in
cash from t-1 to t and divided by lag market value of equity, ⊿Earning stands for change in earning
from t-1 to t and divided by lag market value of equity, ⊿NA stands for change net asset from t-1
to t and divided by lag market value of equity, ⊿INT shows change in interest from t-1 to t and
divided by market value of equity, ⊿D change in dividend from t-1 to t divided by lag market
value of equity, CHt-1 stands for lag cash divided by lag market value of equity and mktlev shows
market leverage which is calculated total debt divided by total debt +market value of equity
The result of table 4.4 shows descriptive statistics. The result indicates that average
excess return of full sample; concentrated industries; non-family firms; Shariah and non-
Shariah compliant firms are negative. On the contrary, average excess return is positive in
competitive industries and family firms .All independent variables are divided by lag market
value of firms following the methodology of Faulkender and Wang (2006); Dittmar and
Mahrt-Smith (2007); Jain et al (2013); Alimov (2014).
Change in cash is positive and stable in all cases. Change in earning is negative in
concentrated industries, non-family firms and Shariah compliant firms. Similarly, change in
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net asset is less from 1 in concentrated, non- family and non Shariah firms. Lag cash is
stable in all sub samples, while market leverage is highest in family firms and lowest in
Shariah compliant firms.
Table 4.5 shows effect of corporate governance on value of cash holding and the role
of product market competition, concentration, family ownership and Shariah compliance
respectively in the relationship of corporate governance and value of cash holding. The table
4.5 reports results of eight models. Dependent variable for each model is the excess return.
The first model shows determinants of value of cash holding and second model shows effect
of governance on value of cash holding. Third model shows effect of governance on value
of cash holding in competitive industries and fourth model shows effect of governance on
value of cash in concentrated industries. Fifth model shows effect of governance on value of
cash holding in family firms and sixth model shows effect of governance on value of cash
holding in non-family firms. Seventh model shows effect of good governance on value of
cash holding in Shariah compliant firms and last model shows effect of good governance on
value of cash holding in non- Shariah complaint firms. The results of these models are
discussed in the proceeding subsections (i.e., 4.2.1 to 4.2.8).
Table 4.5: Effect of Corporate Governance on Value of Cash Holding
Excess
return Full Full Comp Conc Family N-family Sharia N-sharia
⊿CH 0.655 ** 0.862 *** 0.962 ** 0.251 0.728 0.860 ** 0.511 0.478
(0.301) (0.302) (0.404) (0.473) (0.472) (0.432) (0.358) (0.598)
gov*⊿CH 0.570 *** 0.846 *** 0.333 0.809 *** 0.480 -0.246 1.040 ***
(0.138) (0.200) (0.198) (0.182) (0.322) (0.232) (0.211)
gov -0.053 -0.037 -0.104 ** -0.008 -0.149 *** -0.071 -0.026
(0.033) (0.043) (0.049) (0.042) (0.054) (0.049) (0.043)
⊿Earning 0.018 * 0.012 0.014 0.070 *** 0.028 ** 0.040 -0.013 0.028 **
(0.010) (0.010) (0.013) (0.024) (0.011) (0.046) (0.032) (0.012)
116
⊿NA 0.003 0.004 -0.005 -0.022 0.004 0.008 -0.017 * 0.006
(0.003) (0.003) (0.004) (0.015) (0.004) (0.011) (0.009) (0.005)
⊿INT -0.186 *** -0.181 *** -0.129 ** -0.528 *** -0.187 *** 0.078 0.069 -0.232 ***
(0.051) (0.051) (0.057) (0.152) (0.056) (0.171) (0.104) (0.060)
⊿D -0.107 ** -0.093 * 0.029 -0.068 0.182 * -0.279 0.250 0.191 *
(0.052) (0.052) (0.081) (0.104) (0.098) (0.234) (0.166) (0.104)
CHt-1 0.126 *** 0.124 *** 0.095 0.136 ** 0.128 * 0.149 0.090 0.160 ***
(0.045) (0.044) (0.071) (0.055) (0.050) (0.110) (0.073) (0.060)
CHt-1*⊿CH -0.054 0.049 -0.111 0.174 0.186 * 0.173 -0.226 0.260 ***
(0.051) (0.056) (0.094) (0.082) (0.076) (0.214) (0.180) (0.084)
mktlev 0.250 *** 0.265 *** 0.286 *** 0.231 *** 0.290 *** 0.158 * 0.360 *** 0.221 ***
(0.058) (0.058) (0.077) (0.085) (0.083) (0.083) (0.087) (0.079)
mktlev*⊿CH -0.714 ** -0.763 ** -0.647 -0.379 -0.578 -0.938 -0.255 -0.288
(0.363) (0.360) (0.480) (0.599) (0.529) (0.581) (0.443) (0.682)
cons -0.138 ** -0.124 ** -0.114 -0.109 -0.136 -0.099 -0.199 *** -0.068
(0.059) (0.059) (0.088) (0.070) (0.088) (0.075) (0.077) (0.085)
F-pvalue
0.000 0.000 0.000 0.000 0.002 0.001 0.000
R2
0.070 0.092 0.151 0.108 0.088 0.088 0.116
N
1137 729 405 702 435 290 550
Table4.5 shows effect of corporate governance on value of cash holding. Second column shows determinants of value of
cash holding, while third column shows effect of governance on value of cash holding. Fourth column shows effect of
governance on value of cash holding in competitive industries, while fifth column shows role of governance on value of
cash in concentrated industries. Sixth column shows role of governance on value of cash holding in family firms, while
seventh column shows role of governance on value of cash holding in non-family firms. Column eight shows role of
good governance on value of cash holding in Shariah compliant firms and last column shows role of good governance
on value of cash holding in non-Shariah complaint firms. The dependent variable is excess return which is calculated
using 25 Fama and French (1993) size and book to market ratio using monthly data from 2007 to 2014 and then
annualized and deducted from annual return of individual firm. Gov is a dummy variable measured through dividing
corporate governance index in terciles where highest tercile is assigned 1 and 0 is for the middle and lowest tercile.
Competition is measured through HHI index dividing in tercile with 1 for lowest tercile and 0 for middle and lowest
tercile. ⊿CH (change in cash), ⊿Earning (change in earning), ⊿NA (change in net asset), ⊿INT (change in interest), ⊿D
(change in dividend), and CHt-1 (lagged cash) are control variables. All control variables are divided by lag market
value of equity except market leverage. First term shows coefficient of variable and term in bracket is standard error. All
models are run with time dummies and industry fixed effect and standard error cluster firm level *, **, *** shows
significance at 10%, 5% and 1%.
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4.2.1 Determinates of value of cash holding
The second column of Table 4.5 shows result for the determinants of value of cash
holding following the work of Faulkender and Wang (2006); Dittmar and Mahrt-Smith
(2007). The result shows that change in cash has significant effect on value of shareholders
as suggested by Faulkender and Wang (2006). Similarly, change in earning and change in
net asset also have positive and significant effect on value of cash holding. On the other
hand, change in interest and change in dividend have significant negative affect on excess
return. .
The interaction term of lagged cash and change in cash is negative significant and
indicates that value of cash is high in firms with low level of cash compared to firms with
high level of cash. Similarly, the interaction term between market leverage and change in
cash is also negatively significant and indicates that market leverage decreases shareholder
value. Shareholders value cash less in firms with high debts because as leverage increases
extra cash is distributed among debt holders instead of shareholders. These results are in line
with the findings of Faulkender and Wang (2006) who also suggested negative significant
relationship of these interaction terms.
The results suggest that the value of cash to shareholders with firm having zero cash
and zero leverage is 0.655. The marginal value of cash to shareholders is 0.215 which is
found by adding the coefficient of change in cash plus coefficient of interaction terms
multiply by their respective mean values measured as (0.655+(-0.054*0.176)+(-.714*0.601).
The result shows that firms average cash contributes to the shareholders wealth by 0.215 for
1PKR extra investment.
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4.2.2 Corporate governance and value of cash
The third column of table 4.5 addresses the issue whether corporate governance
effect value of cash? The result shows that the interaction term of governance and change in
cash is positive and significant. In the regression governance variable is dummy variable
with 1 for good governance and 0 for bad governance. The governance dummy variable is
created by dividing the governance index into terciles and assigning 1 for highest tercile and
0 for middle and lowest tercile. The positive sign of interaction term shows that shareholder
wealth increases in good governance firm by 0.570PKR as compared to the firms that have
bad governance. The result is supported by Dittmar and Mahrt-Smith (2007) who also found
similar result.
Similarly, the marginal value of cash holding under good governance is 0.982PKR
(which is measured as 0.862 + (0.049*0.176) + (-0.763*0.601) + 0.570) for one extra
Pakistani rupee, whereas it is 0.462 in firms having bad governance. The result is supported
by (Dittmar & Mahrt-Smith, 2007; Pinkowitz et al., 2006; Uddin, 2016) who also found
similar result. Value of cash to the shareholders is decrease by 0.570PKR due to bad
governance. The result is also supported by agency theory (Jensen, 1986) which suggests
that due to agency problem managers destroy excess cash of firm on value destroying
activities and ultimately decreases firm value. The result confirms the application of agency
theory that due to agency problem, firm value decreases and corporate governance increases
firm value. On the basis of above result H2a hypothesis of the research is supported that
corporate governance has significant and positive effect on value of cash holding and that
marginal value of cash holding is high in good governed firms compared to bad governed
firms.
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4.2.3 The effect of corporate governance on value of cash holding in competitive and
concentrated industries
The present research also investigated that whether the relationship of corporate
governance and value of cash vary across different industries and ownership structures. To
answer this query we split our sample into firms that belong to competitive industries on
particular year and firms that belongs to concentrated industries respectively. The result
presented in column four and five shows that good governance has significant effect on
value of cash holding in competitive industries compared to concentrated industries. The
result shows that corporate governance dummy and change in cash interaction has positive
significant effect on value of cash holding in competitive industries. The result posits that
firms with good governance increases value of cash holding by 0.845PKR compared to
firms with bad governance in competitive industries. The marginal value of corporate
governance on value of cash holding in competitive industries is 1.37 measured as 0.962+(-
0.111*0.165)+(-0.647*0.642)+0.842. The result posits that shareholders wealth increases
more for extra 1PKR invested by shareholders.
In contrast, the effect of governance on value of cash holding is insignificant in
concentrated industries indicating that strong governance is comparatively more effective in
competitive industries than the concentrated industries. Effect of good governance dummy
and change in cash interaction on value of cash holding is insignificant in concentrated
industries. The marginal effect of governance on value of cash holding in concentrated
industries is 0.387PKR which is measured as (0.251+(0.0174*0.198)+(-
0.379*0.527)+0.333). The marginal effect of governance on value of cash holding in
competitive industries is comparatively 0.985-PKR higher than the effect of governance on
the value of cash holding in concentrated industries for extra 1PKR. The result is supported
by the work of Jain et al. (2013), they also found that the effect of good corporate
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governance on value of cash holding is significant only in competitive industries compared
to concentrated industries.
Similarly, Alimov (2014) analyzed the effect of product market competition on value
of cash holding in good governance and bad governance firms and found insignificant
result. He claimed that product market competition has effect on value of cash holding but
the effect is insignificant for both good governance and bad governance firms. His finding
does not support agency theory. In contrast, Amman et al. (2011) supported substitution
effect argument and claimed that external market discipline substitute internal governance.
They found that strong corporate governance has insignificant effect on firm value in
competitive industries compare to concentrated industries. The difference of our study and
Amman et al (2011) study is that they measured firm value on Tobin Q and interacted
governance index and product market competition. This research adopted the methodology
of Faulkender and Wang (2006); Dittmar and Mahrt-Smith (2007) and measured firm value
through change in cash.
The substitution argument claims that even if company has weak governance
mangers are still forced by external market discipline to work in the best interest of
shareholders (Holmstrom, 1982; Nalebuff and Stiglitz, 1983; Hart, 1983; Giroud & Mueller,
2010, 2011; Guadalupe & Perez-Gonzalez, 2010). Similarly, Schoubben and Hulle (2013)
found that industry competition and industry concentration both have effect on value of cash
holding in weak governance firm. Moreover, industry competition and industry
concentration has insignificant effect on value of cash holding in strong governance firms.
The result of this research is supported by complementary hypothesis that corporate
governance has significant effect on value of cash holding in competitive industries
compared to concentrated industries. Complementary hypothesis claim that product market
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competition need efficient internal governance to reduce agency problem and ultimately
increase value of firm. In Pakistan competition commission of Pakistan work hard to ensure
healthy competition in the market but the size of registered industries is very low in Pakistan
stock exchange. On the basis of these facts Pakistan’s economy has only moderate level of
competition. Therefore, Pakistani companies need both external market discipline and good
internal governance to improve value of cash holding.
On the basis of results our H2b hypothesis is accepted that product market
competition has complementary effect for corporate governance in relationship with value
of cash holding.
4.2.4 The effect of corporate governance on value of cash holding in family and non-
family firms
The sixth and seventh column of table 4.5 indicates the effect of corporate
governance on value of cash holding in family and non-family firms respectively. The
extant research suggests two views on family controlled firm’s activities. The first view is
supported by stewardship theory and the second view is supported by agency theory.
According to stewardship hypothesis managers are steward of the company and despite of
agency problem managers of family control firm does not expropriate company free cash
and do not spend it on value destroying investments.
On the contrary, according to agency theory that family controlled firms serve the
interest of family instead of common shareholders and want to transfer business to next
generation (Kuan et al., 2011). The agency theory supports empire building hypothesis i.e.,
family firms want to make empire for their family members and for next generation. In
family firms due to high agency problem controlling family expropriate free cash and spend
it on value destroying investments which could serve the interest of family on the cost of
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minority shareholders (Yeh et al., 2001). Therefore, there is need of strong internal
governance to align interest of managers and shareholders to protect minority shareholders.
Boubaker et al., (2015) found that family control firms have negative effect on value
of cash because family control firms have high level of agency problem compare to non-
family firms. So, negative effect of family control on value of cash is altered by good
governance. In line with these views our result indicates that interaction term of good
governance dummy and change in cash is positively significant.
The result shows that change in cash under good governance in family firms add
firm value by 0.809PKR more than family firms with poor governance. The marginal value
of cash for family firms having good governance is 1.186. The result is interpreted in a way
that for one extra Pakistani rupee, good governance increases shareholder wealth by
1.186PKR in family firms. The result is supported by agency theory compare to stewardship
theory that due to agency problem controlling shareholders want to make empire for
particular family. Family firms want to fulfill their legacy and make value destroying
investment for their own benefit at cost of minority shareholders. Therefore, corporate
governance mitigate agency problem and result in increased firm value.
On the other hand, the result also shows effect of corporate governance on value of
cash holding in non-family firms. The interaction term of corporate governance dummy and
change in cash is insignificant. The result shows that cash does not add to firm value under
good governance in non-family firms. The marginal value for one extra Pakistani rupee in
non-family firm is 0.898 under good governance. The result shows that corporate
governance has a higher effect on value of cash holding in family firm compared to non-
family firms and the difference is 0.288. The result postulates that good governance
contributes to value of cash holding only in family firms compared to non-family firms.
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The result of this research accepted H2c hypotheses is that corporate governance
increases value of cash holding in family firms
4.2.5 Effect of corporate governance on value of cash holding in Shariah compliant and
non Shariah compliant firms
The last two column of Table 4.5 signify the effect of corporate governance on value
of cash holding in Shariah compliant firms and non- Shariah compliant firms respectively.
In Pakistan firms must fulfill certain criteria for inclusion in the list of Shariah compliant
firms. For example, their maximum short and long term debt to total asset should be 37%,
liquid assets should be at most 33% of their total assets. Similarly, the firm must have
generated less than 5% revenue from non-compliance investment. Moreover, their illiquid
assets to total assets ratio must be less than 25%. Jensen (1986) claimed that lower debt is
substitute for good governance. Since, Shariah compliant firms maintain lower debt (not
more than 37% of their total assets). Moreover, Shariah compliant firm have low liquid
asset up to maximum 33%. Therefore, keeping in the view of Jensen (1986) Shariah
compliance can be regarded as a substitute to good governance and due to Shariah
compliance agency problem is reduced. Moreover, recent article of Hayat and Hassan
(2017) also claims that Shariah compliance is alternative to good governance.
The result of this research posits that interaction of corporate governance and change
in cash shows insignificant effect on value of cash holding in Shariah compliant firms. This
result supports substitution base argument that Shariah compliance is alternative to good
governance that is why corporate governance has no role in Shariah compliant firms. On the
contrary, the result for non-Shariah compliant firm shows that corporate governance has
positive and significant effect on excess return and ultimately increases value of cash
holding. The marginal value is 0.9299 for one extra Pakistani rupee in non-Shariah firms
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under good governance. The result posits that good governance increases value of cash
holding in non- Shariah compliant firm as compared to Shariah compliant firm. On the
basis of above discussion it is concluded that Shariah compliance is substitute to corporate
governance. Therefore H2d hypothesis is accepted that corporate governance has different
effect on value of cash holding in Shariah and non-Shariah compliant firms and Shariah
compliance is substitute to corporate governance in value of cash holding relationship.
4.3 Effect of corporate governance and excess cash on industry adjusted capital
expenditure
This section presents the results corresponding to objective 3 and sub-objectives 3a,
3b, 3c. The essence of this section is to investigate whether value of cash holding is
enhanced due to utilization of excess cash in the presence of corporate governance. This will
help in conceptualizing the role of corporate governance in the spending of excess cash on
value enhancing investment.
Following Harford et al. (2008); Amman et al. (2011); Jain et al. (2013) dissertation
considers utilization of excess cash in three ways including (change in industry adjusted
capital expenditure, dividend payments and diversification).
Table 4.6 shows the effect of corporate governance and excess cash interaction on
industry adjusted capital expenditure. Furthermore, table 4.6 shows effect of corporate
governance and excess cash interaction on industry adjusted capital expenditure in
competitive and concentrated industries; family and non-family firms; Shariah and non-
Shariah compliant firms. Table 4.6 reports results of seven models. Dependent variable for
each model is the change in industry adjusted capital expenditure. The first model shows the
role of corporate governance on excess cash and industry adjusted capital expenditure
relationship. Second and third model shows the role of corporate governance on excess cash
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and industry adjusted capital expenditure relationship in competitive and concentrated
industries respectively. Similarly, model 4 and 5 signify the role of corporate governance on
excess cash and industry adjusted capital expenditure in family and non-family firms
respectively. The last two models investigate the role of corporate governance on excess
cash and industry adjusted capital expenditure in Shariah compliant and non-Shariah
complaint firms respectively.
Each model has six controlled variables including: cash flow (cflow), industry
adjusted cash flow volatility (indcv), leverage of the firm (lev), net working capital (nwc),
size of the firm (size), and market to book ratio (mtob).
The results of these models are discussed in the proceeding subsections.
Table 4.6: Role of corporate governance and utilization of excess cash on industry adjusted
capital expenditure (Dependent variable ⊿Ind-capex)
Full com conc family
Non-
family shariah
Non-
shariah
excesst-1 -0.004 * -0.005 *** -0.008 *** -0.007 *** -0.002 -0.006 ** -0.007 ***
(0.002) (0.002) (0.002) (0.002) (0.007) (0.002) (0.002)
excesst-
1*gov -0.109 -0.579 *** -0.129 -0.395 * -0.174 -0.189 -0.206 *
(0.189) (0.269) (0.165) (0.207) (0.319) (0.199) (0.115)
gov 0.017 0.008 0.064 *** 0.015 0.047 * 0.012 0.019
(0.012) (0.010) (0.023) (0.012) (0.027) (0.017) (0.012)
cflow -0.010 0.127 ** -0.084 0.020 0.051 -0.051 0.154
(0.050) (0.053) (0.064)
(0.071)
(0.136) (0.066)
(0.061)
indcv -0.249 *** 0.250 ** 0.220 ** 0.434 ** 0.033 0.197 * 0.274 **
(0.081) (0.109) (0.109) (0.137) (0.210) (0.114) (0.123)
lev -0.096 *** -0.075 ** -0.210 *** -0.154 *** -0.098 * -0.165 *** -0.113 **
(0.031) (0.033) (0.046) (0.043) (0.058) (0.042) (0.041)
nwc -0.064 ** -0.091 *** -0.146 *** -0.122 *** -0.050 -0.135 *** -0.109 ***
(0.026) (0.027) (0.030) (0.035) (0.083) (0.032) (0.026)
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size 0.019 *** 0.017 *** 0.021 *** 0.020 *** 0.021 ** 0.017 *** 0.016 **
(0.004) (0.004) (0.004) (0.004) (0.007) (0.004) (0.005)
mtob -0.022 ** -0.010 0.037 *** 0.030 ** -0.049 0.007 0.002
(0.010) (0.010) (0.013) (0.013) (0.045) (0.013) (0.011)
cons 0.114 *** 0.112 *** 0.046 * 0.118 *** 0.100 ** 0.103 *** 0.078 ***
(0.025) (0.020) (0.026) (0.024) (0.040) (0.019) (0.038)
R-square 0.110 0.143 0.251 0.160 0.137 0.216 0.216
F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000
N 1350 870 477 836 514 290 550
The Second column shows role of corporate governance and excess cash on industry adjusted capital expenditure.
Third and fourth column shows role of corporate governance and excess cash on industry adjusted capital
expenditure in competitive industries and concentrated industries respectively. Similarly, the columns 5 to 8 show
the same phenomenon in family, non-family Shariah compliant, and non-Shariah compliant firms respectively.
Excess stands for lagged excess cash is independent variable Gov dummy is measured by dividing corporate
governance index in terciles on yearly basis with 1 for firms in the highest tercile and 0 for firms in the middle
and lowest tercile. Cflow stands for cash flow, while indcv stands for industry adjusted cash flow volatility, lev
stands for leverage, nwc stands for net working capital, size stands for size of the firm and mtob stands for market
to book ratio. All models are run with time dummies, industry fixed effect and standard error cluster with firm
level. First term is coefficient of variables and term in bracket shows standard error *, **, *** shows significance
at 10%, 5% and 10%.
4.3.1 Effect of excess cash on industry capital expenditure in good governance firms
The extant literature indicates that corporate governance play significant role on
utilization of excess cash which ultimately effect value of cash holding (See for example,
Harford et al., 2008; Jain et al., 2013). Following Harford et al. (2008); Amman et al.
(2011); Jain et al. (2013) dissertation considers utilization of excess cash in three ways
including: 1) change in industry adjusted capital expenditure 2) change in industry adjusted
dividend 3) diversification. .
Table 4.6 shows the effect of lag excess cash on change in industry adjusted capital
expenditure in good governance firm. The corporate governance is used as dummy variable
127
by dividing corporate governance into terciles. The highest tercile is assigned 1 and other
lowest and middle tercile assigned 0. On the other hand, excess cash is calculated as the
difference between actual and predicted cash. Residual cash is obtained from regression
from determinants of cash identified from work of Opler et al. (1999). The second column
of table 4.6 shows that the effect of interaction of lagged excess cash and corporate
governance is insignificant on industry adjusted capital expenditure in full sample. The
result shows that good governance has no role on utilization of excess cash in form of
industry adjusted capital expenditure. The result of dissertation does not support agency
theory that suggests that corporate governance leads to efficient utilization of excess cash.
Harford et al., (2008) found positive effect of lag excess cash on industry adjusted capital in
good governance firms and found insignificant effect of lag excess cash on industry adjusted
capital expenditure under bad governance. In contrast Jain et al., (2013) found negative
relation between lag excess cash and industry adjusted capital expenditure under good
governance.
The control variable cash flow which has insignificant effect on industry adjusted
capital expenditure. Similarly, the industry adjusted cash flow volatility has negative and
insignificant effect on industry adjusted capital expenditure. The result is supported by
precautionary cash motive which suggests that as cash volatility increases firms maintain
high cash to buffer against external shocks. Moreover, companies whose cash flow volatility
is higher than the industry median make less internal investment compared to their
respective industry. The marginal effect is that one unit increase in cash flow volatility
decreases industry adjusted capital expenditure by 0.249.
Similarly, leverage has significant negative relationship with industry adjusted
capital expenditure (capex), one unit increase in leverage decreases industry capital
expenditure by 0.096. So, the result shows that as debt increases, firm will repay interest and
128
principal on time and if company is unable to repay, chances of bankruptcy may be arise.
Therefore, when debt increases firms does not prefer spending of excess cash in the form of
industry adjusted capex. Harford et al., (2008) also shows negative but insignificant
relationship of leverage with industry adjusted capex. Moreover, net working capital also
shows negative and insignificant relationship with industry adjusted capex. This result is in
line with Jain et al. (2013) who also found negative relationship of networking capital with
industry adjusted capex.
On the other hand, size of the company shows positive and significant relationship
with industry adjusted capex. In line with Jain et al. (2013) the result shows that large
companies have high capex compared to industry average other things remain constant.
Similarly, market to book ratio which is an indicator of growth opportunity shows that
companies that have high growth opportunities in future make less investment in form of
capex compared to their respective industry in which they operate.
The proceeding sections investigate whether the role of corporate governance in
utilization of excess cash in the form of industry adjusted change in capex is same or
different across different industries and firms ownerships. Section 4.3.2 considers
competitive and concentrated industries, section 4.3.3 considers family and non-family firms
while, section 4.3.4 considers Shariah compliant and non-Shariah compliant firms.
4.3.2 Effect of corporate governance on excess cash and industry adjusted capital
expenditure relationship in competitive and concentrated industries
The result in column 3 and column 4 shows utilization of lagged excess cash in the
form of industry adjusted change in capex under corporate governance in competitive and
concentrated industries. The result shows that the interaction of lagged excess cash with
good governance has significant negative effect on industry adjusted capex in competitive
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industries. The result portray that in presence of good governance, excess cash is relatively
less utilized on capex in competitive industry. In contrast, corporate governance has no role
in utilization of excess cash in form of capex in concentrated industries. Jain et al. (2013)
found negative but insignificant effect of excess cash utilization in form of capex in firms
from competitive and concentrated industries. The results of this research supported
complementary hypothesis that product market competition still needs good governance to
reduce agency problem and efficient utilize excess cash.
4.3.3 Effect of corporate governance on excess cash and industry adjusted capital
expenditure relationship in family and non-family firms
The result of column 5 and 6 in table 4.6 posits the role of governance on utilization
of excess cash in form of capital expenditure (capex) in family and non-family firms.
Research shows that family owned firms have high agency problem therefore, controlling
shareholders of family firm’s waste excess cash in value destroying investments. Hence,
there is need of proper governance in mitigation of agency problem and efficient utilization
of excess cash. In line with this view the result posits that lagged excess cash and
governance dummy has negative and significant effect on industry adjusted change in capex
in family firms. The coefficient of interaction term shows that well governed family owned
firms spend 0.395 less money on industry adjusted capex compare to the poorly governed
family firms.
The controlled variables have almost same signs and significance level as indicated
in first column except cash flow. That is leverage, networking capital and market to book
ratio has negative relationship with industry adjusted capex. Similarly, size and industry
adjusted cash flow volatility has positive and significant relationship with industry adjusted
capex. However, cash flow is positively significant, while it is insignificant in first column.
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The result of column 6 shows insignificant effect of interaction term of lag excess
cash with corporate governance dummy on industry adjusted change capital expenditure.
This means that governance has no role in utilization of excess cash in form of capex in non-
family firms. The result posits that agency problem is high in family firms compared to non-
family firms and good governance play significant role in family firms to control agency
problem between controlling shareholders and minority shareholders.
4.3.4 Effect of corporate governance on excess cash and industry adjusted capital
expenditure relationship in Shariah compliant and non-Shariah compliant firms
This section investigates the role of corporate governance in utilization of excess
cash in form of capital expenditure (capex) in Shariah and non- Shariah labeled firms. The
result in column 7 shows that interaction term of corporate governance dummy and lag
excess cash has negative but insignificant relationship with industry adjusted change in
capex. The result shows that coefficient of excess cash is negative and significant which
indicates that Shariah compliance leads to efficient utilization of excess cash in poor
governance firms because the effect of omitted group is capture in main variable i-e., excess
cash. Therefore, we can conclude that Shariah compliance is substitute to good governance
as suggested by Hayat and Hassan (2017).
On the other hand, the result of interaction term of corporate governance and lag
excess cash shows significant negative relationship with industry change capex in non-
Shariah compliant firms. The result is interpreted in way that good governance work better
in non-Shariah compliant firms as compare to Shariah compliant firms in resolving agency
problem. The result of column 8 posits that excess cash is 0.229 utilize less in non-Shariah
compliance firm in form of industry change in capex under good governance as compare to
poor governance firms.
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The control variables including cash flow and market to book ratio shows
insignificant relationship with industry change capex, while industry adjusted cash flow
volatility, leverage and networking capital have significant effect on industry change in
capital expenditure (capex).
4.4 Effect of corporate governance on excess cash and dividend relationship
As discussed earlier, this dissertation considers utilization of excess cash in three
ways following Harford et al. (2008); Amman et al. (2011); Jain et al. (2013) including: 1)
change in industry adjusted capital expenditure 2) dividend payments 3) diversification.
This section considers the utilization of excess cash for dividend payments. Table 4.7 shows
the effect of corporate governance on utilization of excess cash in form of dividend, and the
role of product market competition, family ownership, and Shariah compliance respectively
in this relationship. The Table 4.6 reports results of seven models. Dependent variable for
each model is dividend which is measured 1 for dividend paying firms and 0 for non-paying
firms. The first model shows the role of corporate governance on excess cash and dividend
payout relationship. Second and third model shows the role of corporate governance on
excess cash and dividend payout relationship in competitive and concentrated industries
respectively. Similarly, model 4 and 5 signify the effect of corporate governance on excess
cash and dividend payout relationship in family and non-family firms respectively. The last
two models investigate the joint effect of corporate governance and excess cash on dividend
in Shariah compliant and non-Shariah complaint firms respectively.
Each model has six controlled variables including: cash flow (cflow), industry
adjusted cash flow volatility (indcv), leverage of the firm (lev), net working capital (nwc),
size of the firm (size), and market to book ratio (mtob). The results of these models are
discussed in the proceeding subsections.
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Table 4.7: Role of corporate governance on excess cash and dividend relationship
div full com conc family
N-
family sharia
N-
sharia
excesst-1 0.064 0.127 *** 0.208 *** 0.159 *** -0.120 * 0.371 *** 0.062
(0.050) (0.033) (0.046) (0.035) (0.062) (0.139) (0.050)
excesst-
1*gov 0.138 *** 0.045 0.191 ** 0.056 0.294 *** 0.227 0.132 ***
(0.024) (0.054) (0.090) (0.056) (0.090) (0.222) (0.027)
gov -0.157 -0.186 -0.201 -0.264 ** -0.042 -0.304 -0.179 *
(0.101) (0.120) (0.223) (0.118) (0.259) (0.435) (0.108)
cflow 0.018 * 0.025 0.011 0.014 * 0.601 *** 0.035 ** 0.026
(0.010) (0.020) (0.008) (0.008) (0.078) (0.016) (0.022)
indcv -0.036 ** -0.131 *** -0.023 -0.114 *** 0.000 -0.116 -0.034 **
(0.015) (0.025) (0.016) (0.025) (0.014) (0.104) (0.016)
lev -0.003 -0.003 0.005 -0.012 ** 0.018 ** -0.091 0.002
(0.004) (0.006) (0.007) (0.006) (0.008) (0.084) (0.004)
nwc 0.097 *** 0.083 *** 0.179 *** 0.132 *** 0.083 *** 0.095 0.102 ***
(0.022) (0.027) (0.034) (0.028) (0.024) (0.102) (0.024)
size 0.002 0.009 ** 0.000 0.002 0.025 *** 0.021 0.002
(0.002) (0.004) (0.003) (0.003) (0.008) (0.016) (0.002)
mtob 0.004 0.026 * -0.017 0.016 0.043 *** 0.177 ** 0.002
(0.006) (0.014) (0.025) (0.017) (0.008) (0.087) (0.006)
cons 0.942 *** 0.744 *** 1.139* 1.112 0.920 0.813 1.044
(0.297) (0.377) (0.604) (0.507) (0.439) (0.759) (0.359)
F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000
Pseudo R2 0.210 0.224 0.276 0.213 0.459 0.510 0.210
Second column of Table 4.6 shows role of corporate governance on excess cash and dividend relationship.
Third column shows role of corporate governance on excess cash on dividend relationship in competitive
industries. Fourth column shows the same phenomenon in concentrated industries. Fifth column considers
family firms, while sixth column considers non-family firms Seventh column eight shows Shariah compliant
firms and eighth column considers non-Shariah compliant firms. Dependent variable is dividend which is
dummy variable with 1 for firms that pay dividend and 0 for firms that do not pay dividend in a particular
year. Independent variable is lagged excess cash interected with governance dummy. Cflow stands for cash
flow, while indcv stands for industry adjusted cash flow volatility. Lev stands for leverage, while nwc stands
for net working capital. Size stands for size of the firm and mtob stands for market to book ratio. All models
are run with probit model .First term is coefficient of variables and term in bracket shows standard
error.*,**,*** shows significance at 10%,5% and 10%.
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4.4.1 Effect of excess cash with good governance on dividend
Table 4.7 shows utilization of excess cash in form of dividend. The result shows that
interaction term of lagged excess cash with corporate governance dummy shows positive
and significant effect on dividend. This result is supported by flexibility hypothesis (Jensen,
1986) that firms with strong level of governance hold less cash. Shareholders under good
governance prefer excess cash distribution in form of dividend. Moreover, under strong
corporate governance, minority shareholders pressurize firm management to distribute
excess cash in the form of dividend. The result is in line with Laporta et al. (2000) who also
found that corporate governance has positive relationship with dividend payout. Moreover,
they suggested that dividend payment is high in countries where investor’s protection is
high. Similarly, agency theory (Jensen, 1986) claims that dividend payment protects
minority shareholders from the exploitation of majority shareholders when agency problem
is high. Therefore, dividend payment is tool to resolve agency problem and free cash flow
problem. Harford et al. (2008) found that excess cash has positive significant effect with
industry change in dividend in poor governance firms. Their result supports spending
hypothesis that firm with governance dissipate excess cash quickly.
The substitution model and outcome model also explain the role of dividend.
According to substitution model dividend payment is high in companies where internal
governance is weak and dividend is substitute for governance to resolve conflict between
shareholders and mangers (Amina, 2015). In contrast, outcome model claims that dividend
payment is high in companies or countries where internal governance is strong and investors
are highly protected. Our result is in line with outcome model that excess cash with strong
governance increase dividend. Furthermore, Amman et al. (2013) found that dividend
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increases firm value in good governance firms. Our result is also in line with Kowalewski et
al. (2007) who also found that dividend is high in good governed firms compare to poor
governed firms.
4.4.2 Utilization of excess cash in the form of dividend under good governance in
competitive and concentrated industries
Column 3 & 4 signify the utilization of excess cash in the form of dividend under
strong governance in competitive industries and concentrated industries respectively. The
result shows that interaction term of lagged excess cash and governance dummy shows
insignificant effect on dividend in competitive industries. The result postulated that in
competitive industries shareholders trust the company to hold cash and pay fewer dividends.
These results support substitution effect argument of product market competition for
corporate governance in the utilization of excess cash in form of dividend. The agency
problem is resolved by external market discipline and don’t need internal governance. The
result posits that good governance has no role in utilization of excess cash in competitive
industries. In contrast, interaction of governance dummy and lagged excess cash has
positive significant effect on dividend in concentrated industries.
Good governance work well in utilization of excess cash in concentrated industries
compared to competitive industries in form of dividend. This result is also supported by
substitution based argument that for efficient utilization of excess cash and control of
agency problem, efficient internal governance is needed in concentrated because lack of
external market discipline.
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4.4.3 Utilization of excess cash in the form of dividend under good governance in
family and non-family firms.
The research also investigates utilization of excess cash under strong corporate
governance in family and non-family firms. Result of column 5 & 6 of table 4.7 shows
utilization of excess cash in form of dividend in family and non-family firms respectively
under strong governance. The result of interaction between corporate governance dummy
and lagged excess cash shows insignificant effect on dividend in family firms. Family firms
have insignificant difference in the utilization of excess cash under good and poor
governance. The result here supported by argument that shareholders value less dividend
payments in the firms with good governance. The shareholders of family firms have
confidence that excess cash will not be expropriated by managers and big shareholders due
to strong internal governance of the firm. The result is also supported by dividend
substitution model that dividend is substitute for corporate governance to control agency
problem.
The control variables including cash flow and net working capital show positive and
significant relationship with dividend. On the other hand, cash flow volatility and leverage
shows significant and negative relationship with dividend, while market to book ratio and
size shows insignificant relationship with dividend. Our result is different from Wei, Wu,
and Chen (2011) who found that family ownership has negative relationship with dividend
and this relationship altered (i.e., becomes positive) when family ownership is interacted
with institutional ownership. Our result is different form Wei et al. (2011) because we have
considered family and non-family firms. Moreover, our interaction term is different from
interaction term of Wei et al. (2011).
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Column 6 of table 4.7 shows the effect of utilization of cash in non-family firms with
good corporate governance. The result shows that interaction of lagged excess cash with
corporate governance dummy shows positive significant relationship with dividend in non-
family firms. The result posits that utilization of excess cash in form of dividend under good
governance is 0.293PKR more in non-family firm compared to non-family firms with poor
governance. The result posits that shareholders prefer dividend in non-family firms when the
governance is strong. This result is supported by outcome model instead of substitution
model. Therefore, on the basis of these results we conclude that utilization of excess cash in
the form of dividend under good corporate governance is higher in non-family firms
compared to family firms.
4.4.4 Utilization of excess cash in the form of dividend under good governance in
Shariah compliant and non- Shariah compliant firms
Column 7 and 8 of table 4.7 shows utilization of excess cash in Shariah compliant
and non- Shariah compliant firms under strong corporate governance. The result of column
7 shows interaction of lagged excess cash and corporate governance dummy has
insignificant effect on dividend in Shariah compliant firm. This result is support by
substitution model of dividend that Shariah compliance is substitute to good governance
(Hayat & Hassan, 2017; Ullah & Rizwan, 2018). Therefore, Shariah compliance is enough
to control agency problem alone and internal corporate governance has not much
importance in controlling agency problem for efficient utilization of excess cash.
Moreover, in Shariah compliant firms low agency problem exist that’s why
shareholders value dividend less in Shariah compliant firms. Another interpretation is that
Shariah compliant firms have low free cash flow problem compared to non-Shariah
compliant firms (Hayat & Hassan, 2017). That’s why shareholders do not worry about
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expropriation of firm excess cash by large shareholders and entrenched management. Excess
cash alone is significant positively means that Shariah compliant firms increase dividend
under poor internal governance.
On the other hand, the result of column 8 shows that interaction of lagged excess
cash and corporate governance dummy have positive and significant effect on dividend in
non-Shariah compliant firms. The result is again supported by agency theory (Jensen, 1986)
that entrenched manages prefer distribution of excess cash in form of dividend. This
indicates that shareholders prefer excess cash to be distributed among shareholders in the
form of dividend when firm governance is strong and agency problem is minimized due to
dividend payment. The interaction term shows difference of utilization of excess cash in the
form of dividend under good and poor governance in non-Shariah compliant firms.
Dividend outcome model is applicable in non-Shariah compliant firms because these firms
has high debt and the chances of bankruptcy is higher in non- Shariah compliant firms
compare to Shariah compliant firms.
4.4.5 Effect of corporate governance on excess cash and corporate diversification
relationship
Diversification is important strategy for company. Economist finds out negative
relationship of corporate diversification and firm value (e.g., Lang & Stulz 1994; Berger &
Ofek, 1995). The negative relationship was justified on the basis of agency theory.
Whenever, firms have high agency problem they involve in unrelated diversification. The
essence of this section is to investigate whether value of cash holding is enhanced due to
utilization of excess cash on diversification in the presence of strong corporate governance.
This will help in conceptualizing the role of corporate governance in the spending of excess
cash on value enhancing diversification.
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Table 4.8 shows the role of corporate governance on spending of excess cash in form
of diversification. The dissertation also checked the role of corporate governance on
spending of excess cash in form of diversification in competitive and concentrated
industries; family and non-family firms; Shariah and non-Shariah compliant firms. Table
4.8 reports the results of seven models. Dependent variable for each model is diversification
measured as 1 for diversified firm and 0 fir stand-alone firms. The first model shows the role
of corporate governance on spending of excess cash in form of diversification. Second and
third model show the role of corporate governance on spending of excess cash in form of
diversification in competitive and concentrated industries respectively. Similarly, model 4
and 5 signify the role of corporate governance on spending of excess cash in form of
diversification in family and non-family firms respectively. The last two models investigate
the role of corporate governance on excess cash and diversification relationship in Shariah
compliant and non-Shariah complaint firms respectively.
Each model has six controlled variables including: cash flow (cflow), industry
adjusted cash flow volatility (indcv), leverage of the firm (lev), net working capital (nwc),
size of the firm (size), and market to book ratio (mtob).
The results of these models are discussed in the proceeding subsections.
Table 4.8: Role of corporate governance on spending of excess cash in form of diversification
(dependent variable diversification)
Diversification full com conc family
N-
family sharia
N-
sharia
excesst-1*gov -0.067 ** -0.068 ** -0.046 -0.126 *** 0.005 0.043 -0.073 **
(0.028) (0.034) (0.059) (0.037) (0.052) (0.134) (0.029)
excesst-1 0.074 *** 0.100 *** 0.050 ** 0.111 *** 0.037 -0.063 0.079 ***
(0.016) (0.023) (0.024) (0.022) (0.040) (0.090) (0.017)
gov -0.374 *** -0.371 *** -0.725 *** -0.744 *** -0.193 -0.847 ** -0.390 ***
(0.087) (0.109) (0.166) (0.111) (0.177) (0.331) (0.092)
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cflow -0.001 0.001 -0.004 0.002 0.027 -0.009 0.002
(0.005) (0.007) (0.006) (0.005) (0.024) (0.007) (0.007)
indcv -0.027 *** -0.020 -0.041 -0.008 -0.118 *** -0.005 -0.029 ***
(0.010) (0.014) (0.027) (0.018) (0.035) (0.084)
(0.010)
lev 0.006 0.007 0.010 * 0.010 0.007 -0.033 *** 0.010 **
(0.004) (0.006) (0.006) (0.010) (0.005) (0.009) (0.004)
nwc -0.032 *** -0.032 ** -0.022 -0.047 ** -0.030 ** -0.308 *** -0.021 **
(0.010) (0.013) (0.015) (0.019) (0.013) (0.062) (0.010)
mtob -0.057 *** -0.093 *** -0.007 -0.070 *** -0.032 -0.147 * -0.054 ***
(0.014) (0.019) (0.022) (0.018) (0.026) (0.085) (0.014)
size 0.005 *** 0.005 * 0.004 ** 0.029 *** -0.005 ** -0.007 0.005 ***
(0.002) (0.003) (0.002) (0.006) (0.003) (0.015) (0.002)
cons 0.367 *** 0.460 *** 0.216 *** 0.840 *** -0.048 1.196 *** 0.355 ***
(0.043) (0.059) (0.068) (0.068) (0.064) (0.200) (0.046)
Prob > chi2 0.000 0.000 0.000 0.000 0.003 0.000 0.000
Pseudo R2 0.047 0.061 0.062 0.141 0.045 0.340 0.045
N 1350 870 475 834 514 290 550
Table 4.7 shows role of corporate governance on excess cash and diversification. Second column shows role of corporate
governance on excess cash and industry adjusted capital expenditure in competitive industries, third column considers
concentrated industries, fifth column considers family firms, seventh column considers non-family firms, eight column
considers Shariah compliant firms and column 10 shows non-Shariah compliant firms. Dependent variable is diversification
which is a dummy variable with 1 for diversified and 0 for non-diversified firms. Independent variable is lagged excess cash
which is residual of determinant of cash holding and moderating variable is gov dummy which is measured by dividing
corporate governance index in terciles on yearly basis with 1 for firms in highest tercile and 0 for firms in middle and lowest
tercile.. All models are run with probit model. First term is coefficient of variables and term in bracket shows standard
error.*,**,*** shows significance at 10%, 5% and 10%.
Column 2 of table 4.8 posits the result about utilization of excess cash on
diversification under strong governance that further effects firm value. The result shows that
interaction of lagged excess cash and corporate governance dummy shows negative and
significant relationship with corporate diversification. The result shows that the coefficient
of interaction term is -0.066 which shows that 0.066 PKR less excess cash is spent by well
governed firms on diversification compared to poorly governed firms. Agency theory
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provides possible explanation for firms involve in diversification. For example, Jensen
(1986) claimed that when excess cash increases mangers can use it at their discretion to
increase diversification. So, due to agency problem firms invest excess cash on
diversification. Amihud and Lev (1981) found that mangers involve in diversification to
decrease their own level of risk instead of overall firm risk is because due to agency
problem. Similarly, Chen and Steirner (2000) found the same result which is in support of
agency theory that firms due to agency problem channel their discretionary cash flows
towards diversification. Therefore, diversified firms face high agency cost as compared to
stand-alone firms (Rajan et al., 2000; Subramaniam et al., 2013). On the basis of this
discussion we conclude that good corporate governance reduces spending of excess cash on
diversification.
In line with Chen and Steiner (2000) the coefficient of excess cash shows positive
and significant relationship with diversification shows that poor governed firms’ increases
channelizing excess cash towards diversification. These results are supported by agency
theory (Jensen, 1986) i.e., due to agency problem managers spend excess cash on
diversification that benefit managers to lower their risk instead of overall firm and internal
good governance is needed to resolve agency problem.
The other control variables like cash flow and leverage shows insignificant
relationship with diversification, while industry adjusted cash flow volatility shows negative
and significant relationship with diversification. Similarly, market to book ratio also shows
negative relationship with diversification.
Column 3 and 4 of table 4.8 shows effect of excess cash under good governance on
diversification in competitive and concentrated industries. The result of column 3 shows that
interaction between lagged excess cash and corporate governance dummy shows negative
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effect on diversification in competitive industries. There are two different points of view
about corporate governance and product market competition relationship i-e., substitution
effect and complementary effect. The result shows that competitive industry need good
governance for efficient utilization of excess cash. This result is supported by the
complementary hypothesis because external market discipline needs strong internal
governance. In competitive industries companies goes toward diversification compared to
concentrated industries because in competitive industries companies want to take
competitive edge. On the other hand, the result of column 4 of table 4.8 shows that corporate
governance has insignificant effect on utilization of excess cash in form of diversification in
concentrated industries. The result is supported by complementary effect argument that for
efficient utilization of excess cash, strong internal governance and external market discipline
both are needed, and in concentrated industries external market discipline is weak.
Furthermore, column 5 and 6 of table 4.8 shows effect of excess cash on
diversification under good governance in family firms and non-family firms. The result of
interaction between lagged excess cash and corporate governance dummy shows negative
and significant relationship with diversification in family firms. The coefficient value of
interaction term is -0.126 indicating that spending of excess cash on diversification under
good governance in family firms is less than spending of excess cash on diversification
under poor governance in family firms. Family firms generally have high agency problem
compared to non-family firms (Lien and Li., 2013). The family firms involve in
diversification under empire building hypothesis i.e., due to diversification family firms
want to create empire for particular family. Furthermore, family members want to transfer
business to next generation that’s why family businesses channel excess cash towards
diversification (Lien & Li., 2013). Column 6 in table 4.8 shows that interaction of lagged
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excess cash with corporate governance firms in non-family firms and result posits that
interaction term has insignificant effect on diversification.
Column 7 and column 8 of table 4.8 show effect of utilization of excess cash under
good governance in Shariah compliant and non-Shariah compliant firms. The result shows
that interaction term between lagged excess cash and good governance dummy posits
insignificant effect on diversification in Shariah compliant firms. This is because Shariah
compliance is substitute to good governance. Therefore, good governance does not affect
utilization of excess cash significantly in Shariah compliant firm. On the other hand, the
interaction of lagged excess cash with good governance dummy posits significant negative
effect on diversification. The coefficient value of interaction term is -0.073 which indicates
that non-Shariah compliant firms spend 0.073 less on diversification under good governance
compared to the similar firms under poor governance.
Keeping in view the results of Table 4.6, Table 4.7, and Table 4.8 it can be
concluded that corporate governance has significant role on utilization of excess cash.
Therefore, the hypothesis H3a is accepted. Similarly, the role of corporate governance in
the utilization of excess cash is significant in competitive industries compared to
concentrated industries; therefore hypothesis H3b is accepted that corporate governance
has significant role on utilization of excess cash in competitive industries
Moreover, the result supported H3c hypothesis that corporate governance has
significant effect on utilization of excess cash in family firms. Similarly, the result also
supports H3d hypothesis that corporate governance has insignificant effect on utilization of
excess cash in Shariah compliant firms and shows that corporate governance has significant
different effect on utilization of excess cash in Shariah and non-Shariah compliant firms.
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4.5 Role of product market competition, family ownership and Shariah compliance on
utilization of excess cash
For robustness table 4.9 shows role of product market competition, family ownership
and Shariah compliance in utilization of excess cash. Column 2-4 consider utilization of
excess cash in competitive industries, column 5-7 consider the same phenomenon in
Shariah compliant firms, while column 8-10 consider family owned firms.
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Table 4.9: Role of competition, family ownership and Shariah on spending of excess cash
⊿Indcapex Div diver indchgcapex div diver ⊿Indcapex div diver
cflow 0.104 * 0.018*** 0.831 0.011 0.018 *** -0.001 0.115 ** 0.017 *** 0.002
(0.058) (0.005) (0.512) (0.052) (0.005) (0.006) (0.045) (0.005) (0.006)
indcv 0.339 *** -0.037*** -0.035** 0.254 *** -0.036 *** -0.040 ** 0.293 *** -0.037 *** -0.028 *
(0.089) (0.009) (0.015) (0.081) (0.009) (0.016) (0.060) (0.010) (0.015)
lev -0.181 *** -0.004 0.007* -0.103 *** -0.004 0.008 * -0.154 *** -0.003 0.003
(0.034) (0.005) (0.004) (0.032) (0.005) (0.004) (0.038) (0.005) (0.004)
nwc -0.142 *** 0.103*** -0.007 -0.078 *** 0.097 *** -0.006 -0.148 *** 0.106 *** 0.003
(0.035) (0.012) (0.011) (0.026) (0.013) (0.011) (0.030) (0.013) (0.010)
mtob 0.010 0.004 -0.040*** -0.018 * 0.006 -0.038 *** 0.018 0.001 -0.032 **
(0.024) (0.007) (0.014) (0.010)
(0.008) (0.014)
(0.018) (0.008) (0.014)
size 0.022 *** 0.002 0.005*** 0.019 *** 0.002 0.005 *** 0.017*** 0.003 * 0.005 ***
(0.004) (0.001) (0.001) (0.004) (0.001) (0.001) (0.003) (0.002) (0.001)
excesscasht-1 -0.003 0.187*** 0.112*** -0.004 ** 0.145 *** 0.103 *** -0.004** 0.252 *** -0.463
(0.003) (0.029) (0.021) (0.002) (0.020) (0.019) (0.002) (0.041) (1.067)
excesscasht-1*comp -0.970 *** -0.047 -0.873***
(0.309) (0.032) (0.306)
comp 0.079 *** 0.179 0.278
(0.020) (0.176) (0.184)
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⊿Indcapex Div diver indchgcapex div diver ⊿Indcapex div diver
Sharia
-0.247 * 0.012 2.613 *
(0.142) (0.031) (1.334)
excesscasht-1*shariah
0.016 0.221 ** -0.340 ***
(0.013) (0.101) (0.127)
excesscasht-1*family
0.062 *** -0.111 *** 0.090 ***
(0.013) (0.042) (0.021)
family
-0.615*** 0.195 * 0.741 ***
(0.161) (0.111) (0.102)
_cons 0.100 *** 0.832*** 0.161 0.118 *** 0.711 ** 0.026 0.091 *** 0.746 *** -0.301
(0.029) (0.294) (0.259) (0.027) (0.298) (0.264) (0.016) (0.284) (0.277)
p-fvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
R2 0.131 0.206 0.144 0.111 0.207 0.143 0.190 0.211 0.166
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Column 2-4 of table 4.9 consider utilization of excess cash in competitive
industries. Competition is a dummy variable with 1 for companies performing in
competitive industries at particular year and 0 for companies from concentrated
industries at particular year. Dummies are assigned on basis of HHI index divided into
tercile, with lowest tercile assigned as competitive industries and highest tercile is
assigned as concentrates industries. Column 2 considers utilization of excess cash in
the form of industry adjusted capital expenditure (capex). The interaction term of
lagged excess cash and competition dummy shows negative and significant effect on
industry change in capex. The result portrays that excess cash in competitive
industries spend 0.969 less on industry adjusted capex compared to concentrate
industries. The result is supported by agency theory that external market discipline is
one of tool to mitigate agency problem beside efficient internal governance
(Haushalter et al., 2007; Alimov, 2014).
Similarly, column 3 of table 4.9 shows effect of spending excess cash in
competitive industries on utilization of excess cash in the form of dividend. The result
shows that interaction of lagged excess cash and competitive dummy has insignificant
effect on dividend. The result shows that shareholders give less value to dividend in
competitive industries compared to concentrated Industries. The result is consistent
with substitution effect argument of dividend that dividend is substitute for
governance in resolving agency problem.
147
On the other hand, Column 4 of table 4.9 shows effect of excess cash in competitive
industries on utilization of excess cash in the form of diversification. The result shows that
excess cash in competitive industries spend less on diversification. Firms engage in
diversification due to agency problem (Jensen, 1986) and entrenched managers want to
mitigate their own level of risk (Chen & Steirner, 2000). Moreover, external market
discipline has role in reducing agency problem (Amman et al., 2011). Therefore, excess cash
less utilized on diversification in competitive industries.
Similarly, Columns 5-7 of Table 4.9 consider utilization of excess cash in Shariah
compliant firms. Column 2 considers utilization of excess cash in the form of industry
adjusted capital expenditure (capex) in Shariah compliant firms. The result of interaction
between lagged excess cash and Shariah compliance dummy shows insignificant effect on
industry adjusted capital expenditure (capex). The result is supported by substitution
argument that Shariah compliance is substitute to governance. Since, Shariah compliant
firms maintain lower debt therefore we can conclude that Shariah compliance is substitute to
governance. This indicates that excess cash in Shariah compliant firm utilize less on
industry adjusted capital expenditure (capex).
Column 6 considers utilization of excess cash in the form of dividend payments in
Shariah compliant firms. The interaction of lagged excess cash and Shariah compliance
dummy shows positive and significant effect on dividend. The result is supported by
dividend outcome model that firms distribute excess cash in form of dividend whenever
agency problem is lower. Since, agency problem are lower in Shariah compliant firms
(Hayat & Hassan, 2017) that is why excess cash in Shariah compliant firms has positive and
significant effect on dividend. On the other hand, column 7 of table 4.9 shows excess cash in
Shariah compliant firms have significant and negative relationship with diversification.
Previous researches (e.g., Lang & Stulz, 1994; Chen & Steiner, 2000; Rajan et al., 2000;
148
Subramaniam et al., 2013) show that firms goes towards diversification due to agency
problem. However, Shariah compliant firms have low level of agency problem due to their
structure that’s why Shariah compliant firms utilize less excess cash on diversification. On
the basis of table 4.9 hypothesis of this research is supported that excess cash is efficiently
utilized in Shariah compliant firms because Shariah compliance is substitute to strong
internal governance.
Finally, columns 8-10 of Table 4.9 consider utilization of excess cash in family
firms. Column 8 considers utilization of excess cash in the form of industry adjusted capital
expenditure (capex) in family firms. The result shows that interaction of lagged excess cash
and family firms’ dummy (with 1 for family firms and 0 for non-family firms) has positive
and significant effect on industry capital expenditure. This indicates that family firms
inefficiently utilize excess cash due to high agency problem which results in lower value of
firm (Boubaker et al., 2015).
Similarly, column 9 of table 4.9 considers utilization of excess cash in the form of
dividend in family firms. The result shows that interaction of lagged excess cash with family
dummy has significant negative effect on dividend. The result shows that family firms do
not distribute excess cash in form of dividend due to high agency problem. Benjamin,
Razak, Wassiuzzaman, Mokhtarania, and Nejad (2005) also found negative relationship of
family ownership on dividend due to agency problem. On the other hand, column 9 of table
4.9 considers utilization of excess cash in the form of diversification in family firms. The
result of interaction between lagged excess cash and family dummy shows significant effect
on diversification. The result is supported by agency theory and empire building hypothesis
that family firms want to build empire for their family. Moreover, family firms serve the
interest of their family members and want to transfer business to next generation that’s why
family firms involve in diversification (Lien & Li, 2013). Therefore, family firms divert
149
from the goal of maximizing firm value of firm in the wake of transferring firm to next
generation (Grote, 2003).
On the basis of table 4.9 hypothesis of this research is supported that excess cash is
inefficiently utilized in family firms due to agency problem.
4.6 Effect of corporate governance on excess cash and firm performance relationship
Efficient utilization of excess cash with strong corporate governance improves
overall performance of company. Dittmar and Mahrt-Smith (2007) also shows that efficient
utilization of excess cash lead to increase performance of the company. Therefore, this
section investigates the effect of corporate governance and excess cash on firm performance
corresponding to objective 4 and sub objectives 4a, 4b, and 4c.
Many researchers (e.g., Dittmar & Mahrt-Smith, 2007; Harford et al., 2008; Jain et
al., 2013) investigate the relationship of excess cash in strong and poor governaned firms on
operating profit. Though, total factor productivity growth is a superior measure for
performance of company compared to standard accounting ratios on basis that standard
accounting ratios have chance of manipulation by firm (Pattanayak, 2010 & Tian and Twite,
2011). Utilization of total factor productivity growth as a measure for performance in the
relationship of excess cash is lacking in the extant literature. Therefore, this study
investigates relationship of excess cash on firm performance under good governance using
total factor productivity growth for performance.
Section 4.4.1 investigates role of corporate governance on excess cash and total
factor productivity growth relationship, while for robustness section 4.4.2 investigates role
of corporate governance on excess cash and industry adjusted ROA relationship.
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Before considering the combined effect of corporate governance and excess cash on
firm performance, the individual effect of excess cash on firm performance was investigated
across different firms including firms from competitive industries, concentrated industries,
family owned firms, non-family owned firms, Shariah compliant firms and non-Shariah
compliant firms respectively. Appendix 2 shows effect of lagged excess cash effect on total
factor productivity growth and industry adjusted ROA in competitive industries, family
firms and Shariah compliant firms without considering corporate governance variable. The
results indicate that the effect of excess cash on firm performance vary across the selected
groups of firms. Therefore, the role of product market competition, concentration, family
ownership, and Shariah compliance has been considered in the combined relationship of
corporate governance and excess cash with total factor productivity growth.
4.6.1 Role of corporate governance on excess cash and total factor productivity growth
relationship
Table 4.10 shows effect of excess cash on total factor productivity growth and
examined role of corporate governance. Moreover, table 4.10 also portrays effect of excess
cash on total factor productivity growth under good governance in competitive and
concentrated industries; family and non-family firms; Shariah and non-Shariah compliant
firms. The Table 4.10 reports results of seven models. Dependent variable for each model is
the total factor productivity (TFP) growth. The first model shows role of corporate
governance on excess cash and TFP growth relationship in overall sample. Second model
shows role of corporate governance on excess cash and TFP growth in competitive
industries. Third model shows role of corporate governance on excess cash and TFP growth
relationship in concentrated industries. Fourth model shows role of corporate governance on
excess cash and TFP growth in family firms. Fifth model shows role of corporate
governance on excess cash and TFP growth in non-family firms, while sixth and seventh
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model consider Shariah compliant and non- Shariah complaint firms and shows role of
corporate governance on excess cash and TFP growth relationship.
Table 4.10: Role of corporate governance on excess cash and total factor productivity growth
relationship
TFPG Overall com conc family N-family sharia N-sharia
excesst-1 0.006 *** 0.006 *** -0.159 0.003 0.012 *** 0.006**` 0.006 ***
(0.002) (0.002) (0.247) (0.002) (0.004) (0.003) (0.003)
excesst-1*gov 0.488 *** 0.612 *** 0.207 0.819 *** 0.213 0.503* 0.515 *
(0.186) (0.226) (0.350) (0.225) (0.387) (0.260) (0.287)
gov -0.032 *** -0.027 * -0.043 -0.035** -0.028 -0.038*** -0.024
(0.013) (0.014) (0.028) (0.014) (0.033) (0.021) (0.017)
cflow -0.209*** -0.160 ** 0.585*** -0.294*** -0.185** -0.240*** -0.242***
(0.051) (0.064) (0.100) (0.071) (0.081) (0.080) (0.078)
indcv 0.111 0.129 0.093 0.257* 0.075 0.070 0.187
(0.097) (0.116) (0.179) (0.144) (0.145) (0.139) (0.147)
lev 0.066** 0.105 *** 0.117** 0.099** 0.108** 0.059 0.094*
(0.032) (0.040) (0.053) (0.045) (0.054) (0.048) (0.051)
nwc 0.025 0.059 * -0.034 0.120*** 0.003 0.011 0.067
(0.027) (0.035) (0.047) (0.040) (0.040) (0.039) (0.041)
size 0.003 0.004 0.001 0.008 0.000 0.006 0.002
(0.004) (0.005) (0.005) (0.005) (0.006) (0.005) (0.006)
capex -0.058 -0.056 0.000 -0.089* 0.012 -0.196*** 0.155***
(0.039) (0.051) (0.086) (0.050) (0.066) (0.053) (0.060)
mtob -0.017 -0.027 * -0.060*** -0.023*** -0.022 -0.018 -0.010
(0.012) (0.015) (0.020) (0.017) (0.019) (0.018) (0.018)
cons 0.960 *** 0.908 *** 0.920*** 0.890*** 0.991*** 0.948*** 0.970***
(0.066) (0.089) (0.095) (0.088) (0.110) (0.085) (0.123)
f-pvlaue 0.000 0.000 0.000 0.000 0.003 0.001 0.000
R-square 0.101 0.101 0.225 0.131 0.155 0.129 0.169
N 1080 690 387 663 417 270 530
Second column shows role of corporate governance on excess cash and total factor productivity growth
relationship in overall sample. Third column shows role of corporate governance on excess cash and total
factor productivity growth relationship in competitive industries, while fourth column considers concentrated
industries. Fifth column considers the same phenomenon in family firms column, while sixth column considers
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non-family firms. Seventh column considers Shariah compliant firms and eighth column considers in non-
Shariah compliant firms. Dependent variable is total factor productivity growth. Independent variable is lagged
excess cash which is difference between actual and residual of determinant of cash holding. Gov is dummy and
measured by dividing corporate governance index in terciles on yearly basis with 1 for firms in highest tercile
and 0 for firms in middle and lowest tercile. Cflow stands for cash flow, indcv stands for industry adjusted cash
flow volatility, lev stands for leverage, nwc stands for net working capital, size stands for size of the firm and
mtob stands for market to book ratio. All models are run with time dummies, industry fixed effect and standard
error cluster with firm level. First term is coefficient of variables and term in bracket shows standard error.
*,**,*** shows significance at 10%,5% and 10%.
Second column of Table 4.10 shows that excess cash with good corporate
governance increase total factor productivity growth. The interaction term between lagged
excess cash and governance dummy shows positive and significant effect on total factor
productivity growth. The result portray that excess cash under good governance increases
total factor productivity growth and indicates efficient utilization of excess cash. The result
is again supported by agency theory that due to agency problem managers waste value asset
i-e, excess cash and decreases performance of firm. The coefficient of interaction term is
0.488 indicating that excess cash have 0.488 more effect on total factor productivity growth
under strong governance compared to poor governance. These findings are in line with
Harford et al. (2008) also found that lagged excess cash with strong governance has positive
effect on firm performance. Similarly, Dittmar and Mahrt-Smith (2007) also found that the
interaction of lag excess cash with governance dummy has positive and significant effect on
firm performance. They concluded that excess cash under strong governance increases
operating profit which indicates that excess cash is efficiently utilized under good
governance. Our findings support H4a hypothesis that excess cash with strong corporate
governance increases total factor productivity growth.
Control variables including cash flow has significant negative effect on total factor
productivity growth, industry adjusted cash flow volatility has insignificant effect on total
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factor productivity growth, leverage has significant positive effect on total factor
productivity growth. Size has insignificant effect on total factor productivity growth, while
capex has insignificant effect on total factor productivity growth. Growth opportunities
measured by market to book ratio has insignificant effect on total factor productivity growth.
4.6.2 Effect of excess cash with good governance on total factor productivity growth in
competitive industries
In second step we have split the sample into HHI terciles. The industries belonging
to lowest tercile are competitive industries, while highest tercile represent concentrated
industries. The result presented in column 3 shows that lagged excess cash with strong
governance dummy have positive and significant effect on total factor productivity growth
in competitive industries. This result confirms complementary hypothesis instead of
substitution argument. On the contrary, column 4 indicates that lagged excess cash
interacted with strong governance dummy shows insignificant effect on total factor
productivity growth in concentrated industries that again support complementary hypothesis.
The result is in line with Pattanayak (2010) who investigated effect of corporate governance
on firm performance using total factor productivity growth as proxy for firm performance in
competitive and concentrated industries in Indian non- financial sector. He found that
corporate governance has significant effect in competitive industries compared to
concentrated industries and supported complementary hypothesis that external market
discipline needs efficient firm level governance to improve total factor productivity growth.
Similarly, Koke and Jens (2001) found that corporate governance and external market
discipline has complementary effect in total factor productivity relationship. In contrast of
Nickell, Nicolitsas, and Drydin (1997); Tian and Twite (2011) found substitution effect
between corporate governance and product market competition on total factor productivity
relationship.
154
The result of dissertation shows that role of corporate governance is significant on
excess cash and total factor productivity growth in competitive industries compares to
concentrated industries. The result supported H4b hypothesis that corporate governance has
significant role on excess cash and total factor productivity growth in competitive industries.
4.6.3 Effect of excess cash with good governance on total factor productivity growth in
family firms
Similarly, in the third step the research investigates effect of excess cash with
corporate governance on total factor productivity growth in family and non-family firms.
The result presented in column 4 &5 shows that excess cash with good corporate governance
has positive and significant effect on total factor productivity growth in family firms
compare to non-family firms. The result posits that lagged excess cash with good corporate
governance has positive and significant effect on total factor productivity growth in family
firms. On the other hand, lagged excess cash with good corporate governance has
insignificant effect on total factor productivity growth in non-family firms. According to
Anderson and Reeb (2003) family control firms has low performance compared to non-
family firms due to agency problem. This indicates that family firms can improve
performance by reducing agency problems. Family members expropriate free cash flows on
the cost of minority investors that is why proper governance is needed to protect rights of
minority shareholders (Shleifer & Vishny, 1997). So, due to agency problem excess cash in
family firms decrease total factor productivity growth and efficient governance is needed to
improve total factor productivity growth in family firms.
The result supported H4c hypothesis that corporate governance has significant role
on excess cash and total factor productivity growth relationship in family firms.
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4.6.4 Effect of excess cash with good corporate governance on total factor productivity
growth in Shariah compliant firms
Finally, we divide sample into Shariah and non-Shariah compliant firms and
checked the effect of lagged excess cash with corporate governance on total factor
productivity growth in Shariah and non- Shariah compliant firms. The result shows that
interaction term of lagged excess cash and strong governance dummy have positive and
significant effect on total factor productivity growth in both Shariah and non-Shariah
compliant firms. The result postulates that Shariah compliance does not matter on the effect
of excess cash on total factor productivity growth under good governance.
The result does not supported H4d hypotheses that effect of corporate governance on
excess cash and total factor productivity growth is significantly different in Shariah
compliant firms and non-Shariah complaint firms.
4.6.5 Effect of corporate governance on excess cash and industry adjusted ROA
relationship
Following Dittmar and Mahrt-Smith (2007); Harford et al. (2008); Jain et al., (2013)
this section investigates the relationship of lagged excess cash with good corporate
governance on industry adjusted ROA for robustness check.
Table 4.11 shows role of corporate governance on excess cash and industry adjusted
ROA relationship. Moreover, role of corporate governance on excess cash and industry
adjusted ROA relationship is investigated in competitive and concentrated industries; family
and non-family firms; Shariah and non-Shariah compliant firms.
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Table 4.11: Role of corporate governance on excess cash and Industry adjusted ROA
relationship
indroa Full Com Conc Family
N-
family Sharia
N-
sharia
excesst-1 -0.927 *** 0.006 0.003 0.002 0.013 *** -0.006 0.004 ***
(0.074) (0.114) (0.002) (0.001) (0.002) (0.005) (0.001)
excesst-1*gov 0.253 ** 0.540 *** 0.810 *** 0.609 *** 0.311 0.302 0.555 ***
(0.106) (0.109) (0.277) (0.140) (0.207) (0.276) (0.122)
gov -0.030 *** -0.039 *** -0.086 *** -0.047 *** -0.017 -0.040 -0.046 ***
(0.007) (0.007) (0.022) (0.009) (0.017) (0.024) (0.008)
cflow 0.254 *** 0.377 *** 0.301 *** 0.328 *** 0.345 *** 0.261 *** 0.371 ***
(0.030) (0.031) (0.067) (0.044) (0.044) (0.105) (0.032)
indcv -0.181 *** -0.201 *** -0.050 0.029 -0.323 *** -0.663 *** -0.100
(0.054) (0.056) (0.145) (0.089) (0.078) (0.192) (0.061)
lev 0.063 *** 0.008 -0.073 * -0.031 0.045 -0.079 0.004
(0.019) (0.019) (0.043) (0.027) (0.029) (0.062) (0.020)
nwc 0.117 *** 0.062 *** -0.013 0.019 0.050 ** -0.054 0.041 **
(0.017) (0.017) (0.032) (0.025) (0.022) (0.046) (0.017)
size -0.005 ** -0.005 ** -0.001 0.003 -0.009 *** -0.015 * -0.002
(0.002) (0.002) (0.005) (0.003) (0.003) (0.008) (0.002)
capex 0.022 0.009 0.002 -0.020 0.046 -0.064 0.008
(0.022) (0.024) (0.049) (0.031) (0.036) (0.071) (0.025)
mtob -0.003 0.023 *** 0.056 *** 0.037 *** 0.015 0.026 0.034 ***
(0.007) (0.007) (0.016) (0.011) (0.010) (0.029) (0.008)
cons -0.055 0.035 -0.006 -0.062 0.068 0.235 * -0.031
(0.036) (0.042) (0.076) (0.053) (0.058) (0.124) (0.042)
p-value 0.000 0.000 0.000 0.000 0.000 0.000 0.000
R-square 0.441 0.478 0.289 0.314 0.547 0.650 0.368
Second column shows role of corporate governance on excess cash and industry adjusted ROA in overall sample.
Third column shows role of corporate governance on excess cash and industry adjusted ROA in competitive
industries, while fourth column considers concentrated industries. Fifth column considers the same phenomenon in
family firms column, while sixth column considers non-family firms. Seventh column considers Shariah compliant
firms and eighth column considers in non-Shariah compliant firms. Dependent variable industry adjusted ROA.
Independent variable is lagged excess cash and gov dummy which is measured by dividing corporate governance
index in terciles on yearly basis with 1 for firms in highest tercile and 0 for firms in middle and lowest tercile. Cflow
stands for cashflow, indcv stands for industry adjusted cash flow volatility, lev stands for leverage, nwc stands for net
working capital, size stands for size of the firm and mtob stands for market to book ratio. All models are run with
157
time dummies, industry fixed effect and standard error cluster with firm level. First term is coefficient of variables
and term in bracket shows standard error.*,**,*** shows significance at 10%,5% and 10%.
The result shows that effect of lagged excess cash interacted with governance
dummy shows positive and significant effect on industry adjusted ROA. The result shows
that firms efficiently utilize excess cash under good governance, and increases industry
adjusted operating profit. The result is in line with the work of Dittmar and Mahrt-Smith
(2007); Harford et al. (2008); Jain et al. (2013) also suggested positive effect of lag excess
with good governance on industry adjusted ROA. The result of this research also portrays
that excess cash under good governance has high operating profit than the industry median.
Similarly, when the sample is split in competitive and concentrated industries and
result shows that lagged excess cash with good governance has positive and significant
effect on industry adjusted ROA in both competitive and concentrated industries. The third
and fourth column of table 4.11 shows that strong corporate governance increases industry
adjusted ROA in both competitive and concentrated industries and the result rejected both
complementary and substitution effect arguments. This result is in line with Jain et al.
(2013).
On the other hand, when the sample is divided in family and non-family firms and
the result shows that lagged excess cash with strong governance increase industry adjusted
operating profit in family firms as compared to non-family firms. The interaction of lagged
excess cash and corporate governance dummy shows insignificant effect on industry
adjusted ROA in non-family firms (See column 5 and 6 in table 4.11). The coefficient value
of 0.609 shows that lagged excess cash within good governance firms’ increases industry
adjusted ROA more as compare to lagged excess cash within bad governance firms. In line
with Shleifer and Vishny (1997); Anderson and Reeb, (2003) the result is supported by
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agency theory that family firms have high agency problems compared to non-family firms
that is why excess cash with strong governance increases industry adjusted ROA in family
firms.
Finally, this research investigates effect of lagged excess cash interacted with
corporate governance dummy on industry adjusted ROA in Shariah and non-Shariah
compliant firms. The result shows that interaction term is insignificant in Shariah compliant
firms. This result is supported by substitution effect argument which suggests that Shariah
compliance is alternate to good governance and corporate governance does not matter in
Shariah compliant firms. In contrast, the coefficient of interaction between lagged excess
cash and governance dummy is non-Shariah compliant firms are 0.544 and significant. The
result indicates that excess cash effect on industry adjusted ROA is 0.544 more in non-
Shariah compliant firms with good governance compared to the non-Shariah compliant
firms having bad governance.
4.7 Effect of diversification on value of cash holding
Corporate diversification is the most important among three form of spending excess
cash in Pakistan (i.e., industry adjusted capital expenditure, dividend, and diversification)
due to the dominancy of family firms. The family firms are more likely to involve in
corporate diversification for empire building for family members and their successors. The
existence of diversified firms all over the globe including Pakistan is the proof that largely
firms involve in diversification. Moreover, diversified firms have high agency problems
compare to stand-alone firms and reduce firm value through cross-subsidization. The current
dissertation considers this issue and investigated direct effect of corporate diversification on
value of cash holding and check whether diversification reduce value of cash holding due to
agency problem.
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Column 2 of table 4.12 shows effect of diversification on value of cash holding. The
result shows that diversification decrease marginal value of cash by -.225 for one Pakistani
rupee. The result is supported by agency theory and empire building hypothesis that due to
conflict between managers and owner, entrenched managers invests excess cash on value
destroying diversification. This value destroying investment posits negative effect on excess
return. And managers normally create their empire by investing in different industries which
further benefit the mangers and not shareholders. The current result is supported by Tong
(2011) who also found negative effect of diversification interaction with change in cash on
firm excess return. In contrast, Galvan, Pindado and Torre (2014) suggest that relationship
of diversification with firm value is non-linear, i.e., it first posits negative effect on firm
value and then posits positive effect on firm value.
The methodology of this study is different from methodology of Galvan et al. (2014)
because we follow Faulkender and Wang (2006); Dittmar and Mahrt-Smith (2007); Tong
(2011). On the other hand, Galvan et al. (2014) used Tobin Q for measuring firm value,
while the present research uses excess return as a proxy for firm value.
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Table 4. 12: Effect of diversification on value of cash holding(dependent: excess return)
Overall gov=1 gov=0 comp conc family Non-family shariah
non-
shariah
⊿CH 0.441 * 0.526 0.498 0.759 ** -0.379 0.716 * 0.287
0.574 0.182
(0.267) (0.475) (0.336) (0.380) (0.399) (0.371) (0.489)
(0.488) (0.333)
diver*⊿CH -0.268 ** 0.528 *** 0.238 0.457 *** 0.225 -0.336 *** -0.101 0.504 *** 0.156
(0.109) (0.199) (0.152) (0.161) (0.179) (0.128) (0.296) (0.156) (0.195)
diver 0.000 0.025 -0.012 -0.007 0.003 -0.013 -0.030 -0.011 0.020
(0.027) (0.051) (0.032) (0.036) (0.038) (0.037) (0.042) (0.035) (0.040)
⊿Earning 0.019 ** 0.006 0.039 *** 0.020 * 0.083 *** 0.021 ** 0.107 ** 0.036 *** -0.031
(0.009) (0.014) (0.013) (0.011) (0.024) (0.010) (0.042)
(0.011) (0.025)
⊿NA 0.006 *** 0.011 *** 0.013 *** 0.004 -0.031 ** 0.007 *** 0.027 ** 0.009 ** -0.004
(0.002) (0.004) (0.004) (0.002) (0.014) (0.002) (0.013)
(0.004) (0.005)
⊿INT -0.129 *** -0.251 *** -0.055 -0.113 ** -0.424 *** -0.130 *** 0.080
-0.209 *** 0.000
(0.033) (0.087) (0.049) (0.036) (0.142) (0.035) (0.181)
(0.050) (0.071)
⊿D -0.148 *** -0.169 ** -0.051 -0.141 *** -0.018 -0.152 *** 0.691 * 0.043 0.126
(0.043) (0.085) (0.067) (0.053) (0.097) (0.046) (0.360)
(0.092) (0.132)
CHt-1 0.105 ** 0.110 0.084 0.230 *** 0.154 *** 0.081 * 0.210
0.051 0.139 **
(0.044) (0.067) (0.073) (0.070) (0.058) (0.049) (0.150)
(0.060) (0.069)
CHt-1*⊿CH -0.014 *** 0.189 *** -0.008 -0.021 *** 0.061 -0.012 *** -0.305
0.132 ** -0.010
(0.004) (0.062) (0.006) (0.005) (0.060) (0.004) (0.288)
(0.054) (0.007)
mktlev 0.222 *** 0.219 ** 0.219 *** 0.237 *** 0.162 *** 0.224 *** 0.090
0.188 *** 0.321 ***
(0.051) (0.108) (0.059) (0.068) (0.078) (0.071) (0.078)
(0.068) (0.081)
161
mktlev*⊿CH -0.658 ** -0.439 ** -0.696 * -0.709 *** 0.308 -0.806 ** -0.011
-0.768 * -0.097
(0.312) (0.182) (0.388) (0.411) (0.542) (0.424) (0.606)
(0.404) (0.401)
cons -0.127 *** -0.213 *** -0.090 -0.177 ** -0.072 -0.097 -0.096
-0.143 * -0.119
(0.059) (0.119) (0.068) (0.087) (0.073) (0.085) (0.079)
(0.082) (0.081)
F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000 0.002
0.000 0.001
R2 0.053 0.128 0.057 0.081 0.118 0.067 0.086
0.097 0.076
N 1385 393 992 889 493 926 459 530 855
Table4.4 shows effect of diversification on value of cash holding. Second column shows effect of diversification value of cash holding, Third column shows effect of
diversification on value of cash holding in well governed firms, while fourth column shows effect of diversification on value of cash holding in poor governance firms. Fifth
column shows effect of diversification on value of cash in competitive industries, while sixth column shows effect of diversification on value of cash holding in concentrated
industries. Seventh column shows effect of diversification on value of cash holding in family firms and eight column shows effect of diversification on value of cash holding
in non-family firms. Column nine shows effect of diversification on value of cash holding in Shariah compliant firms and column tenth shows effect of diversification on
value of cash holding in non-Shariah compliant firms. The dependent variable is excess return which is calculated through Fama and French (1993) size and book to market
ratio using monthly data from 2007 to 2014 and then annualize and deducted from annual return of individual firm. Diversification is dummy variable 1 for diversified firms
and 0 for non-diversified firms Gov is dummy 1 is measured through dividing corporate governance index in terciles highest tercile is assigned 1 and 0 for the middle and
lowest tercile. Competition is measured through HHI index dividing in tercile 1 lowest tercile and 0 for middle and lowest tercile. Other control variables are ⊿CH shows
change in cash, ⊿Earning shows change in earning, ⊿NA shows change in net asset, ⊿INT shows change in interest, ⊿D shows change in dividend, CHt-1 is lag cash all
controlled variables are divided by lag market value of equity. First term shows coefficient of variable and term in bracket is standard error. All models are run with time
dummies and industry fixed effect and standard error cluster firm firm level, *,**,*** shows significance at 10%, 5% and 1%.
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The results indicate that marginal value of diversified firm is -0.225. The objective H5a
is checked that whether diversification reduces value of firm due to agency problem. The
negative sign indicates that shareholders are getting negative return for 1PKR extra investment
in diversified firm.
The result supported H5a that diversification reduces value of cash holding due to
agency problem.
4.7.1 Effect of corporate diversification on value of cash holding in good and poor
governance firms
The research further investigated effect of diversification on value of cash holding by
splitting the sample into good governance firms and low governance firm. The result of column
3 of table 4.12 shows that the interaction of diversification with change in cash has positive and
significant effect on excess return in good governance firm. This result is supported by agency
theory that shareholders give more value to diversification in good governed firms compared to
bad governed firms. Corporate governance alters the negative relationship of diversification and
value of cash holding. The result also posits that due to good corporate governance, agency
problem is mitigated and mangers invest in value creating diversification. This result is in line
with Tong (2011) who also found that diversification has positive effect on value of cash
holding in good governed firms. The result of column 4 of table 4.12 further posits that
diversification interaction with change in cash has insignificant effect on value of cash in poor
governed firms. The marginal value of cash holding under bad governance is 0.279 (0.498+(-
0.008*0.211)+(-.696*0.655)+0.238) which is significantly lower compared to diversification in
good governed firms. The marginal value of diversification is 0.554 greater in firms that have
good governance compared to poor governed firms.
163
The result supported H5b that diversification increase marginal value of cash holding in
good governed firms.
4.7.2 Effect of corporate diversification on value of cash holding in competitive and
concentrated industries
The research further investigates effect of diversification on value of cash in competitive
industries and in concentrated industries (see, column 5 & 6 of table 4.12). Agency theory and
empirical research posits that competition work as external market discipline and claim that
despite of bad governance mangers act in best interest of shareholder due to external market
pressure. This indicates that competition in product market mitigates agency problem even
when the firm level governance is poor. The result of column 5 depicts that the interaction of
diversification with change in cash shows an increase of 0.457 in the shareholders wealth in
diversified firms compared to a stand-alone firms in competitive industries.
. The marginal effect of diversification on value of cash under competitive industry is
0.757 measured as (0.759+ (-0.021*0.212) + (-0.709*0.642)+0.457). Similarly, the effect of
diversification interaction with change in cash shows insignificant effect on value of cash
holding in concentrated industries due to lack of external market discipline. The marginal value
of diversification on shareholder wealth for one extra PKR invested in concentrated industries is
0.019 measured as (0.379+(0.061*0.1875)+(0.308*0.5277)+0.225). The difference of
diversification for 1PKR extra rupee in competitive and concentrated industry is 0.738. The
result indicates that diversification increases value of cash holding in competitive industries due
to mitigation of agency problem by external market discipline and decreases value of cash
holding in concentrated industries due to lack of external market discipline.
164
The result supported H5c hypothesis that Corporate diversification has positive effect on
value of cash holding in competitive industries.
4.7.3 Effect of corporate diversification on firm value in family and non-family firms
The result of column 7 and 8 of table 4.12 considers effect of diversification on value of
cash holding in family owned and non-family owned firms respectively. The overall result is
comparatively more significant in family owned firms. Managers of family owned business are
engaged in diversification due to agency and also supported to empire building hypothesis.
Controlling shareholders in family owned firms want to transfer their business to next
generation by creating their own empire at the cost of minority shareholders which is the classic
example of agency problem. The result shows that effect of interaction of diversification with
change in cash shows significant effect on value of cash holding in family firms.
The result shows that diversification interaction is -0.336, and result postulates that
diversification decreases shareholder investment for extra 1PKR by 0.336 in family firms. The
result also shows that diversification interaction has insignificant effect in non-family firms.
The marginal value for 1PKR to shareholders in family firm is -0.153PKR that shows value of
cash decreases due to diversification in family owned compared to non-family firms. On the
other hand, in non-family firms the effect of diversification on value of cash is 0.1444PKR for
one extra Pakistani rupee to the shareholders. The difference between effect of diversification
on value of cash in family and non-family firms is -0.298. The result supported H5d that
diversification reduces value of cash holding in family firms.
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4.7.4 Effect of diversification on value of cash holding in Shariah compliant firms
Similarly, the last two columns report the effect of diversification on value of cash in
Shariah compliant and non Shariah compliant firms. The nature of Shariah compliant firms is
different from non- Shariah compliant firms in terms of liquidity, debt ratio and investment.
Research (like, Hayat & Hassan, 2017; Ullah & Rizwan, 2018) shows that Shariah compliance
is substitute to governance because Shariah compliant firms maintain low debt and low debt is
substitute for good governance. Moreover, Shariah complaint firms also maintained low liquid
to asset as compared non-Shariah compliant firms. Therefore, the free cash flow problem is
comparatively lower in Shariah compliant firms compared to non Shariah compliant firms.
The result shows that diversification interaction with change in cash is positive and
significant in Shariah compliant firms as compared to non-Shariah compliant firms. Empirical
result of this study shows that marginal value of shareholder is in Shariah compliant firm is
0.838 PKR compared to 0.272 in non-Shariah compliant firms. The result shows that
diversification decreases value of cash in non-Shariah compliant firms about 0.565PKR for one
extra Pakistani rupee devoted by investors. The result indicates that Shariah compliance is
alternative for corporate governance and diversification increases firm value more in Shariah
compliant firms compared to non-Shariah compliant firms. The effect of diversification on
value of cash holding is lower in non-Shariah compliant firms due to agency problem.
The result supported H5e hypothesis that diversification increases value of cash holding
in Shariah compliant firms.
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CHAPTER 5
CONCLUSION
Cash holding has got importance after financial crises because the firms having
sufficient funds proved more viable during crises period. Firms were facing difficulty in
generating funds during crises period due to capital market inefficiency. Precautionary motive
for cash is most prominent in literature which posits that firms hold cash to defend themselves
from sudden external shocks. The financial hierarchy theory also suggests that internal funds are
the cheaper source of financing compared to external financing.
Though, holding cash is beneficial for firms however, cost is also attached with cash
holding. Therefore, equilibrium is must between benefit of cash holding and cost of cash
holding. If the benefit of cash holding is less from the cost of cash holding it causes reduction in
firm value. The most prominent cost attached with cash holding is the agency cost. Cash is
imperative asset which can be easily expropriated due to agency problem by entrenched
mangers and controlling shareholders for their personal interests. This dissertation investigated
effect of corporate governance on different facets of cash management. The dissertation also
examined whether corporate governance effects vary on different facets of cash management
across different industries and ownership structures. For this purpose, the thesis investigated the
role of product market competition, family ownership and Shariah compliance on the
relationship of corporate governance with different facets of cash management. This study is
important in context of Pakistan because the law enforcement is weak and inefficient compared
to developed economies. Moreover, it posits several findings.
167
First, the present study investigates the effect of corporate governance on level of cash
holding. Findings suggest that corporate governance has negative significant effect on level of
cash holding which support flexibility hypotheses presented by Harford et al. (2008). Moreover,
provides answer to a query, whether the relationship of corporate governance and level of cash
holding varies across different forms of industries and ownership structures. The study
investigates the role of product market competition, family firms’ ownership, and Shariah
compliance on the relationship of corporate governance and level of cash holding relationship.
The result shows that product market competition has substitution effect for corporate
governance in relationship with cash holding. Similarly, family ownership also has significant
effect on corporate governance and cash holding relationship. On the other hand, Shariah
compliance has insignificant effect on corporate governance and cash holding relationship.
Second, this research investigates effect of corporate governance on value of cash
holding and the role of product market competition, family ownership, and Shariah compliance
on the relationship of corporate governance and value of cash holding is investigated. Previous
researches captured value of firm through Tobin Q. However, this research follows Faulkender
and Wang (2006); Dittmar and Mahrt-Smith (2007) to capture value of firm through change in
cash. The measurement of firm value through cash is more valid approach to measure value of
firm because cash is more prone to appropriation by mangers and controlling shareholders in
comparison of other type of assets (Dittmar & Mahrt-Smith, 2007; Jain et al., 2013). The result
posits that corporate governance and change in cash interaction has positive and significant
effect on excess return indicating that corporate governance significantly increases value of cash
holding.
168
Furthermore, the research revealed that corporate governance significantly increases
value of cash holding in competitive industries compared to concentrated industries which
supports complementary hypothesis i.e., external market discipline need efficient corporate
governance for mitigating agency problems. Similarly, the results indicate that corporate
governance increases value of cash holding in family firms. Family firms have high agency
problem between controlling shareholders and minority shareholders and in family firms
corporate governance is needed to mitigate agency problem and significantly increase value of
cash holding. On the other hand, Shariah compliant firms have low agency problems due to
their structure. Therefore, corporate governance has insignificant effect on value of cash holding
in Shariah compliant firms which support substitution effect argument that Shariah compliance
is substitute for corporate governance.
Third, the study attempts to investigate whether corporate governance increases value of
cash holding through efficient utilization of excess cash. This research investigated three
possible way of spending excess cash i.e., industry adjusted capital expenditure, dividend and
corporate diversification. The result shows that corporate governance has positive and
significant effect on spending of excess cash. Similarly, corporate governance shows significant
role in the efficient utilization of excess in competitive industries which is consistent with
complementary hypotheses. Moreover, the result shows that role of corporate governance has
significant effect on utilization of excess cash in family firms because mitigating agency
problem in family firms, controlling shareholders efficiently utilize excess cash. On the other
hand, since Shariah compliance work as alternative to corporate governance on the basis of
substitution effect argument. Therefore, good governance has insignificant role in spending of
excess cash in Shariah compliant firms.
169
Fourth, since that excess cash increases performance of the company due to efficient
utilization of excess cash which further effect value of firm (Dittmar & Mahrt-Smith, 2007).
Therefore, this study investigates role of corporate governance on excess cash and firm
performance and also checks the role of corporate governance in competitive and concentrated
industries, family and non-family firms and Shariah and non-Shariah compliant firms. Total
factor productivity growth has been used as proxy for firm performance, while for robustness
purpose industry adjusted ROA is also used as a proxy of performance. Total factor productivity
growth is more appropriate approach than the single accounting ratio because single accounting
ratio has chance of manipulation (Tian & Twite, 2011). The study revealed that excess cash
increases total factor productivity growth under good governance.
Similarly, corporate governance has significant role on effect of excess cash and total
factor productivity growth in competitive industries compared to concentrated industries as
suggested by support of complementary hypothesis. Findings suggest that excess cash increases
total factor productivity growth under good governance in competitive industries. Moreover,
joint effect of corporate governance and excess cash have positive and significant effect on total
factor productivity growth in family firms compared to non-family firms. The result shows that
family firms have high agency problem between controlling shareholders and minority
shareholders which is mitigated through corporate governance. Therefore, excess cash is better
utilized in family firms under good governance which leads to increase in total factor
productivity growth. On the other hand, corporate governance and excess cash joint effect has
insignificant effect on total factor productivity growth in Shariah compliant firms as suggested
by the substitution affect argument.
170
Finally, since the extant literature shows that firms engage in diversification due to
agency problem and destroy value of firm (Tong, 2011). Moreover, our findings suggest that
among the three ways of spending excess cash diversification is very significantly related to
excess cash. Therefore, this study investigates effect of corporate diversification on value of
cash holding and also examines effect of corporate diversification on value of cash holding in
good governance and bad governance firms; competitive and concentrated industries; family
and non-family firms and Shariah and non-Shariah compliance firms. The study revealed that
diversification reduces value of cash holding due to agency problem. Moreover, diversification
increase value of cash holding in good governed firms and reduces value of cash holding in
poor governed firms. Furthermore, external market discipline helps in mitigating agency
problem; therefore our result shows that diversification increase value of cash holding in
competitive industries. Similarly, family firms engage in corporate diversification for empire
building due to agency problems. Therefore, diversification reduced value of cash holding in
family firms. On the contrary, Shariah compliance is alternate for corporate governance (Ullah
& Rizwan, 2018) and alters the negative effect of corporate diversification on value of cash
holding. Therefore, diversification adds to value of cash holding in Shariah compliant firms.
5.1 Practical Implications
The study has several practical implications
• The study has implication for policy makers to promote corporate governance within
firm because due to corporate governance misallocation of cash is minimized and
ultimately increase firm value.
171
• The study will help investors and especially minority investors to invest in those firms
whom corporate governance is good because due to good governance their interest is
protected from expropriation of controlling share holders
• This study suggest policy makers to improve competition in product market because due
to competition agency problem is minimizes and have complementary role for corporate
governance in Pakistan
• The study will make investors aware about the importance of corporate governance in
family firms because corporate governance increase firm value in family firms. The
study also suggest that minority shareholders should invest in those family firms whose
corporate governance is good
• The study will help to policy makers to promote Shariah compliance in Pakistan
because agency problem is quietly low in Shariah compliant firms, and Shariah
compliance resolve agency problem.
• Firms involve in diversification reduces value of cash of cash holding due to agency
problem. This study will give insight to policy makers to improve firm level governance
that diversification does not harm firm value.
5.2 Limitation
The limitation of the study is that it investigated effect of corporate governance on
different facets of cash management i-e level of cash holding, value of cash holding, utilization
of excess, and performance only in Pakistani context. The structure of corporate governance is
quite different between developed and developing economies. The current study only used one
proxy for corporate governance index due to unavailability of data in Pakistan. The study
extensively investigated role of product market competition, family ownership, Shariah
172
compliance on relationship of corporate governance with different facets of cash management
but the study has limitation that it is only conducted in Pakistani context. Furthermore, the study
has limitation that it only measure product market competition through HHI index. The current
study investigated effect of corporate diversification on value of cash holding and found that
diversification reduces value of cash holding due to agency problem. The study has still
limitation that it only investigated the relationship of diversification and value of cash holding
in context of agency theory and only investigated the relationship in Pakistani context .
5.3 Future direction
The current study suggests some direction for future research. The study should conduct
in future to compare the effect of corporate governance on different facets of cash management
i-e, level of cash holding, value of cash holding, utilization of excess cash and performance in
developed and developing economies. The governance structure and degree of implementation
of corporate governance codes is different between developed and developing economies. The
future study should conduct role of import and export tariffs on corporate governance with
different facets of cash management. The change in import and export tariffs increase or
decrease competition in product market in particular economy. Moreover, Lerner index is also
measure of product market competition at firm level. Therefore, in future the research should
conduct to measure product market competition with HHI index as well with Lerner index to
provide more generalizability.
The current study checked effect of corporate governance on level of cash holding, value
of cash holding, spending of excess cash and performance in family firms. Future research
should conduct to check the effect of corporate governance on different facets of cash in those
173
family firms where founder exist and in those family firms where business transfer to next
generation and then compare the results. Furthermore, Shariah compliance is new concept more
research should conduct using multiple countries data on effect of corporate governance with
different cash policies in Shariah compliant firms. Another direction of this dissertation for
future research is to investigate effect of diversification on value of cash holding in developed
and developing economies and also provide another explanation beside agency theory.
174
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Appendix 1
In this section we estimated excess cash which is measured the difference between
normal cash of each firm at particular year and predicted cash of each firm at particular year.
Predicted cash is the residual cash measured from regression. The variables for regression are
inspired from the work of (Opler et al., 1999). Fama and Macbeth (1973) model is used to
measure excess cash. Fama and Machbeth model is cross-sectional regression that measure
regression on each year. The advantage to measure excess cash through Fama and Macbeth
(1973) model is that serial correlation is normally eliminated. The residual of the following
regression is used as predicted excess cash in the dissertation.
+��ℎ ℎ�����*A =∝ +EF����1A + EG I���;A + EK�;A
+EN�1�A + EP���A + EQ ���A + ER��;A + ER���=A + �A
Cflow=stands for cashflow of company “i” at time “t”
Indcv=stands for industry adjusted cash flow volatility
Lev=stands for leverage of company “i” at time “t”
Nwc= stands for net working capital of company “i” at time “t”
Size= size of company “i” at time “t”
Mtob= market to book ratio of company “i” at time “t”
Div=1 for dividend payment and 0 for no payment of particular company “i” at time “t”
Capex= capital expenditure of company “i” at time “
195
Table 4.13: Determinants of cash holding
Fama-
MacBeth
cash Coef. Std. Err. t
cflow 0.661 0.200 3.3
indcv 0.787 0.305 2.58
lev -1.116 0.177 -6.29
nwc -0.387 0.087 -4.47
capex -0.343 0.159 -2.15
size 0.024 0.012 1.92
div 0.164 0.040 4.08
mtob 0.461 0.056 8.28
cons -1.744 0.123 -14.22
f-
pvalue 0.000
AvgR2 0.306
Result shows that cflow has positive and significant effect on cash: one unit increase in
cash flow increases cash by 0.679. This result is supported by Opler et al., (1999). Indcv shows
positive and significant effect on cash because as industry cash flow volatility increases cash
holding of firms is also increases. This result is supported by precautionary motive because
firms hold cash to depend themselves from external shock. Leverage is substitute for cash as
leverage increases firm maintain less cash because leverage is substitute for cash and transaction
motive of cash is supported this relationship and net working capital also shows negative and
significant relationship with cash and this relationship is again supported by precautionary cash
196
model. Further, size of the firm shows positive and significant relationship with cash, means
that large firms hold high cash as compare to small firms. MtoB which measure investment
opportunity and this relationship is supported by speculative motive of cash because firm who
have high investment opportunities in the market and underinvestment problem may be arise
with insufficient cash. So, firms have high cash with investment opportunity in the market.
Dividend shows significant and positive relationship with cash as firms. Capex shows negative
and significant relationship with cash as firm internal investment increases measure by capex
company level of cash decreases. All variables signs and significance is in line with the work of
(Opler et al., 1999; Dittmar & Mahrt-Smith, 2008)
197
Appendix2
Table 4.14: Effect of Competition Family ownership and Shariah Compliance on Total Factor
Productivity and operating profit
Tfp Indroa
cflow -0.250 *** -0.242 *** -0.238 *** 0.322 *** 0.346 *** 0.254 ***
(0.052) (0.052) (0.051) (0.031) (0.031) (0.030)
indcv 0.091 0.115 0.094 -0.166 *** -0.143 ** -.168 ***
(0.097) (0.097) (0.097) (0.058) (0.059) (0.055)
lev 0.097 *** 0.075 ** 0.097 *** 0.002 -0.023 0.059
(0.033) (0.032) (0.033) (0.019) (0.019) (0.018)
nwc 0.059 ** 0.049 * 0.065 ** 0.056 *** 0.031 * 0.119 **
(0.027) (0.027) (0.027) (0.016) (0.016) (0.016)
size 0.001 0.001 0.003 -0.004 ** -0.004 * -0.004
(0.004) (0.004) (0.004) (0.002) (0.002) (0.007)
mtob -0.030 ** -0.026 ** -0.027 ** 0.023 *** 0.033 *** -0.026 **
(0.012) (0.012) (0.012) (0.007) (0.007) (0.009)
excesst-1 0.004 ** 0.006 *** 0.003 * 0.004 *** 0.006 *** 0.004 ***
(0.002) (0.002) (0.002) (0.001) (0.001) (0.001)
excesst-1*com 0.659 *** 0.540 ***
(0.132) (0.078)
com -0.049 ** -0.019 *
(0.019) (0.011)
excesst-1*shariah 0.557 *** 0.193 **
(0.134) (0.081)
shr -0.042 *** 0.001
(0.013)
(0.008)
excesst-1*family 0.608 *** 0.408 ***
(0.131) (0.078)
family -0.031 ** -0.023 ***
(0.014) (0.007)
cons 0.986 *** 0.991 *** 0.936 *** 0.006 0.009 0.002
(0.066) (0.065) (0.066) (0.038) (0.039) (0.039)
198
F-pvalue 0.000 0.000 0.000 0.000 0.000 0.000
R2 0.113 0.108 0.112 0.379 0.354 0.112
N 1077 1080 1080 1104 1107 1080
199
Appendix 3
This section provides table of 4.2 separately to provide more insight about the
relationship of corporate governance and cash holding. Furthermore, the role of product market
competition, family ownership and Shariah compliance in the relationship of corporate
governance and cash holding is also provided separately.
Table 4.15: Effect of corporate governance on cash holding
cash Coef. Std. Err. t P>t
Govindex -0.325 0.089 -3.630 0.000
cflow 0.908 0.238 3.820 0.000
indcv 0.926 0.439 2.110 0.035
mtob 0.380 0.036 10.550 0.000
size 0.015 0.012 1.230 0.221
lev -0.964 0.118 -8.140 0.000
nwc -0.405 0.111 -3.660 0.000
capex -0.327 0.187 -1.750 0.080
div 0.151 0.045 3.370 0.001
_cons -1.586 0.207 -7.650 0.000
Number of obs 1357 F-value 54.74
R-squared 0.268 Prob > F 0.000
Table 4.16: Effect of corporate governance on cash holding in competitive industries
Cash Coef. Std. Err. t P>t
Govindex 0.162 0.151 1.080 0.282
com 0.168 0.098 1.720 0.085 com*Govindex -0.523 0.178 -2.950 0.003
cflow 0.986 0.225 4.390 0.000
indcv 0.653 0.399 1.640 0.102
mtob 0.239 0.041 5.860 0.000
size -0.013 0.015 -0.870 0.382
lev -0.901 0.118 -7.620 0.000
nwc -0.422 0.104 -4.060 0.000
capex -0.280 0.171 -1.640 0.101
div 0.111 0.042 2.680 0.007
cons -0.770 0.275 -2.800 0.005
200
F-value
23.37 Prob > F 0.000
R-squared 0.428
Table 4.17: Effect of corporate governance on cash holding in family firms and Shariah
compliant firms
Cash Coef. S. E. t P>t Cash Coef. S.E. t P>t
Govindex 0.034 0.186 0.180 0.855 Govind -0.196 0.091 -2.150 0.032
family*Govindex -0.368 0.208 -1.770 0.077 shria 0.085 0.109 0.780 0.438
family -0.046 0.042 -1.090 0.277 sharia*Govind -0.107 0.214 -0.500 0.616
cflow 0.893 0.221 4.050 0.000 wcflow 0.998 0.234 4.270 0.000
indcv 0.657 0.420 1.560 0.118 windcv 0.670 0.410 1.630 0.103
mtob 0.241 0.044 5.520 0.000 wlnmtob 0.232 0.044 5.320 0.000
size -0.016 0.016 -0.990 0.321 wsize -0.013 0.016 -0.830 0.407
lev -0.908 0.127 -7.170 0.000 wlev -0.887 0.127 -7.000 0.000
nwc -0.434 0.107 -4.070 0.000 wnwc -0.410 0.107 -3.820 0.000
capex -0.269 0.174 -1.550 0.122 windcapex -0.278 0.175 -1.590 0.113
div 0.113 0.041 2.790 0.005 div 0.109 0.041 2.670 0.008
Cons -0.561 0.268 -2.090 0.037 _cons -0.670 0.273 -2.450 0.014
F( 42, 1313)
33.67
F( 41, 1314) 23.61 Prob > F
0.000
Prob > F
0.000
R-squared
0.425
R-squared 0.424