Earnings quality, institutional investors and corporate cash holdings: evidence from India

Abstract

PurposeThis paper aims to examine the relationship between earnings quality and corporate cash holdings in an emerging economy. Existing literature posits that earnings quality is a result of information asymmetry and firms with lower earnings quality increases cash holdings, to shield the firm from future uncertainties. In this paper, the authors propose a ‘private benefits hypothesis’, which suggests that lower earnings quality is an indicator of opportunism and expropriation of resources in the firm, through tunneling or excessive executive compensations. As a result, firms with lower earnings quality increase cash holdings in their control, to increase their private benefits and to avoid the scrutiny of the external stakeholders. The authors further examine the monitoring role played by institutional investors on cash holdings, with varying degrees of earnings quality.Design/methodology/approachThis study uses an unbalanced panel data sourced from Prowessdx, from 2000 to 2019. The analysis employs 20,231 firm-year observations from 2,421 firms. Earnings quality is calculated following Dechow and Dichev (2002).FindingsEmpirical analysis confirms that the firms with higher earnings quality reduce cash. Further, institutional investors reduce the cash holdings in firms with higher earnings quality. Institutional investors effectively reduce the cash only in firms with at least 10% of equity shareholding. The results are robust to alternative measures of earnings quality and endogeneity concerns.Originality/valueThis study diverges from the information asymmetry hypothesis in the existing literature on earnings quality and cash holdings and highlights the underlying private benefits hypothesis, that will impact cash holdings. Next, the 10% institutional shareholding is important in the Indian context as it represents the minimum threshold at which block holders can request extraordinary general meetings (Section 100 of the Companies Act 2013) or the involvement of the National Company Law Tribunal (NCLT) (Section 213 of the Companies Act 2013). This study highlights that unlike in Anglo-Saxon economies, institutional investors or other minority shareholders are empowered by the Companies Act 2013 to play a vital role in corporate governance with a mere 10% equity.

Intellectual capital efficiency, institutional ownership and cash holdings: a cross-country study

“…The findings on firm size are consistent with the European countries listed companies (Alomran, 2023). It supports the pecking order theory, which finds that large-size firms hold more cash.…”

“…However, the GCC countries reported that the existence of investment committees and their interaction with institutional ownership were positively associated with cash holdings. Whereas, the European countries reported negative association between institutional shareholding and cash holding (Alomran, 2023). The findings of firm size lend support to the pecking order theory that propagates that large firms with more profitability are likely to hold more cash.…”

Real Earnings Management and Cash Holding Performance: Auditor Industry Specialization as Moderating Variable

“…(Chang et al, 2018) indicate that REM has a positive impact on stronger cash-holding values in companies with more financial debt constraints. Empirical analysis by Chada & Varadharajan, (2023)confirms that the firms with higher earnings quality reduce cash. Meanwhile, opposite results were found by (Kumar et al, 2023) who found that REM had a negative effect on accounting performance and market performance.…”

Earnings Quality: The Role of Owners

“…Thus, it is assumed that the institutional owner in the unit of analysis is the short-term owner so that the level of ownership weakens the issuer's level of earnings quality. Furthermore, institutional investors reduce their shareholding in firms with higher earnings quality, explaining the negative impact of institutional ownership on earnings quality (Chada and Varadharajan, 2023).…”