The Determinants and Value of Cash Holdings: Evidence from China’s Privatized Firms

Abstract

We study the relation between state ownership and cash holdings in China’s share-issue privatized firms from 1993 to 2007. We find that the level of cash holdings declines as state ownership increases. This negative relation is attributable to the soft-budget constraint (SBC) inherent in state ownership. The Chinese financial system is dominated by the state-owned banks, an environment very conducive for the SBC effect. We further examine and quantify the effect of state ownership on the value of cash and find that the marginal value of cash declines as state ownership increases. The next RMB added to cash reserves of the average firm is valued at RMB 0.94 by the market. The marginal value of cash in firms with zero state ownership is RMB 0.33 – RMB 0.47 higher than in firms with majority state ownership. The SBC effect exacerbates agency problems inherent in state-controlled enterprises, contributing to the lower value of cash.