The Predicament of Excess Cash and M&A in an Agency Conflict Context: Evidence from the U.S

Abstract: This study aims to establish the relationship between cash levels (Opler et al. 1999), shareholder rights (Gompers, Ishii & Metrick 2003) and stock performance focusing on agency conflicts and the free cash flow problem in an M&A context. The data used covers M&A transactions in the U.S between the years 1990 and 2016. The results show a significant impact on the acquisition announcement on the stock performance for firms holding negative excess cash and firms with positive excess cash ratios. However, the difference is more significant on the negative excess cash sample, implying that the market incorporates firms' financials in its pricing and forecasts acquisitions for firms holding excess cash. Moreover, there is an indicative significance in the difference in market reaction around the announcement date depending on high or low shareholder rights when excess cash is positive but not when negative. Firms with positive excess cash and high shareholder rights generally experience higher levels of returns than those with low shareholder rights since these firms avoid the underinvestment problem, and enjoy the other benefits of holding cash, while the risk of overinvestment is limited. On the contrary, the insignificant result regarding negative excess cash shows that companies holding negative excess cash benefit from low shareholder rights since it decreases the risk of underinvestment as managers become less risk averse if the risk of being replaced is low.