Firm Value, Cash Holdings and Information Asymmetry

Abstract

This study examines two conflicting hypotheses. First, based on Myers and Majluf (1984), cash holdings in combination with a higher level of information asymmetry have a positive influence on firm value because the adverse selection costs arising from external finance can be avoided. Second, Jensen's free cash flow theory coupled with a higher level of information asymmetry leads to extreme moral hazard. Instead of paying out the free cash flow to shareholders, managers tend to waste these funds on inefficient investments or on their own pet projects. This study examines the relationship between cash holdings and firm value under information asymmetry assumption. The sample data consists of financial reports of the companies listed in Tehran Stock Exchange (TSE). The data is selected from 105 companies from 1382-1387, using panel data and Least Squares method for coefficients estimation and hypotheses testing. The results show that there is a significant and negative relationship between cash holdings and firm value, holding information asymmetry assumption. The results indicate that agency costs based on the theory of free cash flow outweigh the benefits of financial slack in mitigating adverse selection costs when raising external funds.

Keywords

• firm value
• cash holdings
• information asymmetry
• agency costs