Strategic Corporate Finance: Applications in Valuation and Capital Structure

HOW THE MARKET VIEWS EXCESS CASH

Little empirical evidence exists on the valuation effects of excess liquidity. The few working papers and published studies on corporate cash holdings tend to focus on the determinants and consequences of cash holdings from an operational perspective rather than a capital markets perspective. However, one study cited a stock market valuation premium: Companies with persistent excess cash levels were associated with higher excess enterprise values.9 We have observed similar results but suggest this effect is most pronounced during challenging economic periods and in certain industries with significant growth prospects that are more often challenged by the effects of business cycles and exogenous volatility.

Where Too Much Is a Good Thing

Valuation effects are most pronounced within the industrial, telecom, and media sectors, where the companies that sustained excess cash holdings enjoyed a substantive premium valuation over the valuation of median cash holders in the same industry. These sectors are characterized by higher volatility and business cycle exposure, larger capital requirements, and more significant growth prospects than the sectors where pervasive excess cash holdings do not lead to valuation premiums (power, energy, and consumer).

The 15 to 45 percent premium enjoyed by excess cash holders supports earlier research that found the market will, at times, reward excess liquidity. But this is not true in every industry; however, with several ...