Thus, these factors play a big role in the company determining what would be the optimal level of cash holdings, and is viewed from a number of points-of-view. They state:
In general, shareholders value a marginal dollar of cash at approximately face value. However, we find large cross-sectional differences consistent with existing theory. We document that the quality and volatility of the firm's investment opportunity set, the probability of financial distress, and access to capital impact the value of cash. Firms with good growth options have their cash valued at a premium to those with poor growth prospects. Additionally, cash is less valuable in firms with stable investment programs and those nearer financial distress. Finally, access to capital decreases the value of holding cash. Overall, it appears that both the investment and financing opportunity sets of the firm affect the value shareholders assign to cash holdings. (2)
Thus, one can now see that indeed see that the direction a firm will take in managing its cash assets depends not only on circumstances or factors, but also on what is the driving force of a firm. However, most firms are commonly affected or directed by factors that include, "
investment opportunities, agency costs, and market frictionsaccess to capital, and size of a corporation" (Pinkowitz and Williamson)
3. Can a firm hold "too much" cash What are the downsides of excessive cash holdings Support your answers.
As earlier stated, I am in concurrence with many views that cash may be excessively held by a firm has a tendency to be counterproductive rather than productive. As stated earlier and in Zuckerman's article, having cash levels that may be viewed as "too-much" for a particular firm...
There are indeed certain tradeoffs with each mode of reducing cash holdings. Increased dividend payments indeed increases the public view of the stock, and keeps the shareholders happy, but it creates a precedent that will always be looked at in the future. For example, if a firm declares high dividends this year, and for the next five years cannot match that dividend declaration due to economic and financial problems, shareholders and analysts will state that the company is underperforming thus resulting in fewer profits and less dividends in comparison to the one declared this year.
Share buybacks are a good way of decreasing the equity of a firm, but by decreasing the size of a firm controlled by investor’s equity, puts more power into the control of management which may lead to less checks and balances with regard to corporate acts which normally would alarm a shareholder. Many firms have gone belly up because top management acted in ways that greatly prejudiced the firm despite the voiced out concerns of a minority of shareholders. Indeed, just as the logic underlying this paper is that a balance between cash and debt on a balance sheet is good, so too is a balance between management and shareholder equity in control of a firm.