The Sensitivity of Corporate Cash Holdings to Corporate Governance

Abstract

The average cash holdings of Chinese-listed firms decreased significantly after the split share structure reform in China, which specified a process that allowed previously nontradable shares held by controlling shareholders to be freely tradable on the exchanges. The reduction in cash holdings is greater for firms with weaker governance and firms facing more financial constraints prior to the reform. The reform also significantly reduced the average corporate savings rate, as measured by cash-to-cash-flow sensitivity. These findings are consistent with the premise that the reform removed a significant market friction, which led to better incentive alignment between controlling shareholders and minority shareholders and relaxed financial constraints. Additional analyses show that the reform affects firms' cash management policies, investment decisions, dividend payout policies, and financing choices differently in private firms than in state-owned enterprises. (JEL G32, G34, G35) This paper examines the effect of corporate governance on corporate cash holdings in the context of the split share structure reform commenced in 2005 in China (hereafter, the share reform or the reform). The 2005 share reform specified a time period during which large (and, typically, controlling)