Finance and Accounting

Evidence of cash conservative and low-leverage firms in UK and Germany

Data: UK and Germany(2005-2012) firms’ financial figures (equity, loans, cash in reserves etc. use data from ) http://ukdataservice.ac.uk/.

International Monetary Fund (IMF): the datasets include economic,

?nancial and government statistics;

Organization for Economic Co-operation and Developing (OECD):

among other items, the dataset include labor force, trade, national

account and economic statistics;

World Bank (WB): in particular you should look at the World

Development Indicators (WDI).

1 Describe the theory ?financially conservative policies;

2 Individuate a group (some groups) of fi?rms which are

?financially conservative;

3 Use test for diference in mean to test whether the

grouping criterion you have chosen works;

4 Build up a dummy and test whether some basic

relationships are di¤erent for this group of ?firms;

5 Use logit/probit/regression analysis to test the

alternative hypothesis that the group of fi?rms you have

selected is distressed/conservative.

The aim of this paper is threefold:

1 To de?fine fi?nancial conservatism;

2 To identify a sample of ?rms that adopt persistent ?nancial

conservative policies;

3 To investigate the characteristics of conservative ?rms by focusing on

the role of agency problems (ownership characteristics) in affecting the

choice of a ffinancial conservative policy.

Policy of persistent high-cash reserves (Mikkelson and Partch 2003).

Motives for large cash reserves:

Serve shareholders?interests by providing low cost of ?financing (Almeida

2004, Myers and Majluf 1984);

Serve managers?interests by consuming private bene?ts easily (Jensen

1986).

Policy of persistent low-leverage levels (Minton and Wruck 2001).

Motives for low leverage:

Provides shareholders with fl?exibility in ?financing future investments

(Myers 1984);

Protect managers against expected costs of ?financial distress (Berger et

al. 1997).

Combine both aspects of ?financial conservatism.

Firms may want to attain fi?nancial ?flexibility by adopting both forms

of conservatism at the same time.

Consistent with Capital Structure Theories:

Pecking order theory: ?firms should ?first exhaust internally available

funds and then resort to more expensive external debt;

Agency theory: both FCP may coexist because managers may have

incentives to stockpile cash in order to avoid debt fi?nancing.

Consistent with the evidence that:

Firms with high growth opportunities and leverage-conservative are

cash rich (Kaplan & Zingales, 1998);

Financially (or leverage) constrained ?firms tend to hold large cash

reserves (Fazzari, Hubbard & Petersen, 1996).

Choose ?xed threshold levels of cash holdings and leverage to identify

fi?nancially conservative fi?rms:

A ?rm is said to be ?leverage conservative? if its annual ratio of total

debt to total assets belongs to the . . . first 20% of all fi?rms for ?five

consecutive years (Minton and Wruck 2001).

A ?rm is said to be ?cash conservative?if it holds annually more than

25% of its assets in cash and cash equivalents for fi?ve consecutive

years (Mikkelson and Partch 2003).