Corporate Risk-Taking and Cash Holdings: The Moderating Effect of Investor Protection

Research Question: This paper investigates the association between corporate risk-taking and cash holdings and whether investor protection moderates this association. Motivation: The motives of cash holding have important implications for corporate decisions making and performance. Understanding the relationship between corporate risk-taking and cash holdings across firms in different institutional contexts enhances better comprehension of how companies manage their financial resources. Idea: The perspectives of the precautionary savings and agency theory are employed in setting the views on the link between corporate risk-taking, investor protection, and cash holdings. This study incorporates both sources of managerial incentive at the firm-level i.e. corporate risk-taking and country-level i.e. governance through investor protection in examining the determinants of corporate cash holdings. Data: The dataset comprises 104,687 firm-year observations from 58 countries from 2011-2020. Firm-level data were gathered from Thomson Reuters Fundamentals, while country-level data were extracted from the World Bank. Method/Tools: The regression model employs corporate cash holdings, measured by the proportion of cash and cash equivalents to total assets, as the dependent variable. The test variables are corporate risk-taking which is based on the standard deviation of the return on the asset over three years and investor protection which is based on the strength in control of corruption. Findings: The findings indicate that firms with higher risk incentives exhibit lower cash holdings while firms in countries with high levels of investor protection are shown to have lower cash holdings. However, the negative association between corporate risk-taking and cash holdings is attenuated for firms in stronger investor protection countries as compared to those in weaker investor protection countries. Our findings are robust to various specification tests, such as those that employ alternative variables. Overall, the findings reveal that the strength of country-level investor protection moderates the negative association between corporate risk-taking and cash holdings. Contributions: The findings provide insights into the way country-level governance, through the strength of investor protection, mitigates the agency costs in high-risk-taking firms concerning their cash management.