The Choice of Corporate Liquidity and Corporate Governance

This paper uses the second-generation antitakeover legislation as a natural experiment to understand corporate governance in‡uence on managerial decisions, speci…cally by examining in‡uences on …rms’liquidity choices between cash and loan commitments. These choices di¤er primarily in the allocation of ex-post control rights of …rms’liquidity reserves, which may lead to disagreement among stakeholders about …rms’liquidity choices. The resulting decisions are strongly in‡uenced by their relative bargaining powers, i.e., corporate governance. The introduction of antitakeover laws during the 1980s and 1990s weakened managerial discipline by reducing the threat of takeover. Subsequently, …rms with bad internal governance tended to increase cash holdings relative to loan commitments, but this tendency was signi…cantly weaker for …rms with good internal governance. This is consistent with the optimizing behavior of management which balances private bene…ts of cash against fewer control challenges provided by increased oversight of loan commitments. Findings suggest the choice of corporate liquidity is a channel for corporate governance, and large cash holdings may be a sign of con…dence