A recent piece of research by academics Nils Backhaus and Luc Soenen looking at how to determine if a company is holding excess cash and what the impact is of that, which appears here on AFPOnline, made a very good case for some of the potential pitfalls that companies face when retaining extra cash.
Given the tremendous focus by much of the US business sector on stockpiling cash in recent years, understanding not just the benefits, but also the issues that could arise as a result, is an important exercise that should help finance execs to ensure that cash is put to best use.
Aside from empirically evaluating how to determine what constitutes excess cash, the two authors also looked at how efficiently managers use resources when there is excess cash available, and found that evidence points to greater waste when resources are excessive. However, the authors linked that wastage to the strength of corporate governance and management control over cash resources.
The research suggested that weak corporate control generally led to a decreased value of cash on higher cash positions, as did poor governance.
Noted the authors: “In general, the majority of the scholarly papers find good governance increasing the value of cash with the value of a dollar of excess cash seen at a range of 42 cents to 89 cents for poorly governed firms with a doubling of this value for well governed companies.”
At present keeping extra cash in reserve and building a war chest is clearly still a big drive for US and global companies that are concerned about the faltering global recovery and the broader impact of the European debt crisis.
But given that having excess cash around can be value-dilutive to those resources—as the chance of waste increases—it behoves CFOs to ensure that good governance and controls are in place to ensure that cash is used most effectively.
Plus, the authors of the research found that companies that do hold excess cash tend to do so for a significant period of time—meaning that cash hoarders now were cash hoarders before and will be cash hoarders again—giving even greater import to the need for strong controls around cash utilization.