Abstract
In this paper we evaluate the empirical importance of the contemporaneous presence of financial and labor market imperfections by studying cross-country differences in market valuations of listed companies and firms’ cash holdings. Our results show that, as expected, financial market imperfections are positively correlated with firms’ cash holdings and that the latter are larger wherever employment protection laws (EPL) are stricter. Moreover, stock markets value liquid companies less in economies with higher EPL levels.
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Notes
- 1.
Modigliani and Miller (1963) analyze the impact of financial structure on firm value in the presence of corporate income taxes. Because interest payments on debt are tax deductible, whereas dividends are not, the introduction of corporate taxation implies that the invariance proposition does not hold anymore and affects the firm’s choice of bond vs. equity financing. Indeed, the use of financial leverage adds to firm value via the present value of the interest tax savings on debt financing, with the result that the optimal capital structure of the firm would be 99% debt.
- 2.
Myers (1984) notes the following pecking order for financing decisions: firms prefer internal sources of funds; firms adapt their dividend payout policies to reflect their anticipated investment opportunities; dividends are sticky. Moreover it is possible to find unpredictable fluctuations in profitability and investment opportunities. These elements imply that an internally generated cash flow may higher or lower than investment outlays; if external financing is required, firms issue the safest security first and equity issues remain a last resource.
- 3.
Tax savings arise when earnings are retained rather than paid out because a tax dividend is replaced with a lower tax on capital gains.
- 4.
Variable definitions will be provided below.
- 5.
Unlike Baum et al. (2006) our panel data model is static. We also estimated a dynamic panel data model, but we failed to reject the null hypothesis of the Arellano and Bond test for first order residual autocorrelation.
- 6.
Columns (1) and (2) differ for the type of instruments used: first differences in the first case and levels in the second case. Results for the endogenous variables (INV∕TA and CF∕TA) do not change significantly by using previous period levels of the same variables as instruments; but, according to the Hansen test, the instrument’s power is lower than the case of first-differenced instruments.
- 7.
Calcagnini et al. (2009) showed that EPL reduces firm investment by increasing firm adjustment costs. Smaller growth opportunities, due to less investment, may result in lower market values.
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Calcagnini, G., Gehr, A., Giombini, G. (2010). Cash Holdings, Firm Value and the Role of Market Imperfections. A Cross Country Analysis. In: Calcagnini, G., Saltari, E. (eds) The Economics of Imperfect Markets. Contributions to Economics. Physica-Verlag HD. https://doi.org/10.1007/978-3-7908-2131-4_3
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