Download Do large cash holdings and low leverage always

“Do large cash holdings and low leverage always lead to overinvestment?
Modification of the ex ante overinvestment measure.”
Hyungjin Cho
Coauthored by Lee-Seok Hwang, Hosik Shim, and Bomi Song
Abstract:
This study provides the first empirical evidence on the validity of the ex ante investment
efficiency measure in Biddle, Hilary, and Verdi (2009) and improves its ability to capture
inefficient investments. We find that investments improve rather than deteriorate
future performance for firms that are supposed to be more prone to overinvestment,
which is inconsistent with Biddle et al. (2009)’s expectation. To improve the measure’s
ability to predict suboptimal investments, we modify the measure using the residual
values of cash holdings and leverage after controlling for the dynamic relations among
firm characteristics. We show that our modification improves the power of the measure
to predict the likelihood that firms engage in inefficient investments. We also highlight
the importance of using the modified measure by showing that the previous empirical
result in Biddle et al. (2009) can be different depending on the modification of the
overinvestment measure.