The Effect of Deviation from Optimal Cash Level on Adverse Selection and Moral Hazard in Firms Listed on Tehran Stock Exchange

This study aims to investigate the impact of deviation from optimal level of cash holdings on adverse selection and moral hazard problems. The data set includes 106 listed firms of Tehran Stock Exchange during the period of 2005-2016 and both panel data and cross-sectional data multivariate regressions were utilized in different stage of analysis to test the hypotheses. According to the optimal level of cash holdings, firms were divided into two groups of firms with or without excess cash holdings. The results of the study revealed that lower optimal level of cash holdings increases adverse selection. In addition, higher optimal level of cash holdings leads to moral hazard. In other words, the findings confirmed both pecking order and free cash flow theories. The findings imply that there is a positive relationship between information asymmetry and marginal value of cash holdings. Such a relationship will gradually decrease when the firms hold higher than optimal level of cash and translate into a negative one.