Motives for corporate cash holdings: the CEO optimism effect

Abstract

We examine the chief executive officer (CEO) optimism effect on managerial motives for cash holdings and find that optimistic and non-optimistic managers have significantly dissimilar purposes for holding more cash. This is consistent with both theory and evidence that optimistic managers are reluctant to use external funds. Optimistic managers hoard cash for growth opportunities, use relatively more cash for capital expenditure and acquisitions, and save more cash in adverse conditions. By contrast, they hold fewer inventories and receivables and their precautionary demand for cash holdings is less than that of non-optimistic managers. In addition, we consider debt conservatism in our model and find no evidence that optimistic managers' cash hoarding is related to their preference to use debt conservatively. We also document that optimistic managers hold more cash in bad times than non-optimistic managers do. Our work highlights the crucial role that CEO characteristics play in shaping corporate cash holding policy. KeywordsCash holdings · Liquidity · Cash holdings motive · CEO optimism JEL Classification G30 · G32 · G02 2 IntroductionThe role of cash reserves in corporate financing and investment decisions is changing. Keynes (1936) Yermack (1995). 3 In general, external financing is more expensive than internal financing for firms, particularly for financially constrained firms. Biased managers are much more reluctant to use outside financing than rational managers, since they believe firm value is underestimated in the financial markets and the cost of external financing is thus overpriced. Malmendier and Tate (2005a) find that corporate investment decisions made by overconfident chief executive officers (CEOs) are substantially related to internal funds. Heaton (2002) builds a model to show that optimistic managers will decline positive NPV projects if they have to fund externally for these projects. Hackbarth (2008) shows theoretically that biased managers have higher debt levels than unbiased managers. 4Although prior studies have examined the impact of CEO optimism and overconfidence on corporate decisions, relatively few prior investigations try to determine differences between optimistic and non-optimistic managers in controlling and operating firm liquid assets (motives for cash holdings). To the best of our knowledge, the most relevant papers, though indirectly related, to a connection between CEO overconfidence and cash holdings are those of Malmendier and Tate ( who holds options more than 100% in-the-money is considered to be relatively optimistic. A detailed explanation of the CEO optimism measure is introduced in Section 3. 4 We also consider a less stringent 67% cutoff, which allows us to examine the extent of the CEO optimism effect on the motives for holding cash. This options based measure is widely used in models designed to understand managerial decision making in firms, and there is therefore value in maintaining consistency with these parallel literatures. For example, studies ...

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