The Effect of Promotion on the Value of Excess Cash Holdings: Evidence from SOEs in China

Abstract

On the basis of the optimal sequence financing theory and the agency theory, this paper examines how external investors react to the promotion incentive behavior of SOE executives from the perspective of excess cash holdings. This study finds that the association between political promotion and the value of excess cash holdings is negative. The finding shows that when there is a promotion incentive for executives, external investors give discount to the value of excess cash holdings and the value of excess cash holdings significantly reduce, suggesting that excess cash holdings reflect the “agency view” of promoted executives, and the excess cash reflects the opportunistic motivation of executives, which means that executives are more likely to grab personal interests through cash. The corporate governance mechanism can alleviate the agency problem between managers and shareholders, and improve firm value. We use product market competition and investor protection to measure the corporate governance, and find that product market competition and investor protection are important corporate governance mechanisms. Strong product market competition and investor protection can effectively reduce the excess cash holdings of promoted executives, and alleviate the discount of outside investors to the value of excess cash holdings. Furthermore, we examine how the excess cash held by promoted executives is used to satisfy private benefits. The assessment and promotion mechanism of SOE executives is still “scale oriented”, and the larger the company is, the more resources executives can use for private benefits. We predict and find that SOE executives have strong motivations to extend the scale of firms and are more likely to use the excess cash to do inefficient investments rather than pay cash dividends to shareholders, and the SOEs whose executives have the chance to promote to higher positions are more likely to engage in low quality M&As, but these activities damage shareholders’ wealth, and external investors are more likely to give negative reactions. All of these findings show that the cash holding behavior of political promotion companies reflects its agency problem, which supports the free cash flow hypothesis. The association between political promotion and the value of excess cash holdings is still established when we use Propensity Score Matching, instrumental variables and other robustness test methods. Overall, political promotion executives use firms’ resources to pursue private benefits, and exacerbate agency conflicts between shareholders and managers. The findings can help us to enhance the understanding of incentive effects of political promotion, and have an important policy suggestion for the SOE reform and job market building.