Do all-equity firms destroy value by holding cash?

Abstract

Empirical evidence shows that as of 2006, nearly every fifth large U.S. public corporation was all-equity financed and that the corresponding average cash holding were nearly twice as high as of the average U.S. firm. This paper therefore presents a simple real-options model to characterize the value of cash for all-equity financed firms and analyze its impact on a firm's investment decision. The model shows that precautionary saving may lead to a delay in investment policy compared to the benchmark of full external financing. This is because saving is an option to invest at a lower price in the future and this option has an additional time value, thereby delaying optimal investment. In the context of growth options and external financing frictions cash has extra value but this value is mostly negatively related to volatility. Testing empirically whether all-equity firms destroy value by holding that much cash, I show that on average the market values cash approximately at par. Moreover, cash is rather valued at a premium if the presence of growth opportunities is being controlled for.