Accruals quality, financial constraints, and corporate cash holdings

Abstract

PurposeThe purpose of this paper is to examine how information asymmetry driven by earnings quality affects corporate cash holdings. It also investigates the role that financial constraints play in this effect.Design/methodology/approachThe paper examines a large sample of 6,501 observations of 741 firms listed on Euronext Paris over the period 2000–2015. Earnings quality is computed using the Jones model performance-matched discretionary accruals developed by Kothari et al. (2005): the larger the absolute value of discretionary accruals, the lower the accruals quality.FindingsThe study finds that firms with poor accruals quality hold more cash and that cash holdings in firms of low reporting quality are higher under financial constraints. These results indicate that firms tend to increase their cash reserves in the presence of high information asymmetry which is notably driven by low accounting quality. The findings also suggest that information asymmetry associated with low reporting quality is greater when firms also have strong financial constraints. The study’s conclusions are consistent with the precautionary motive for cash holdings.Practical implicationsThe results would enhance practitioners’ awareness of the importance of accounting choices in the management of cash policies. It would also give researchers an incentive to further explore how these policies are influenced by the precautionary behavior of managers.Originality/valueThis paper is the first work to investigate the effect of accruals quality on corporate cash holdings in the French equity market, which typically has a poor information environment resulting in high information asymmetry. Moreover, the role of financial constraints in this effect has not yet been explored.