Institutional quality and corporate liquidity: the interaction of corruption and judicial efficiency

The purpose of this study is to examine the relationship between institutional quality and corporate cash holdings using a panel data regression analysis, consisting of 20,988 firms across 27 countries for the period of 2010 to 2023. Institutional quality is proxied by judicial efficiency and control of corruption. The study reveals that firms operating in corrupt environments are expected to hold more cash because of both precautionary purposes and the need for liquid assets to facilitate bribery. The findings of the study show a strong positive relationship between corruption and cash holdings. However, a major contribution of this study is that judicial efficiency significantly mitigates this effect. The positive relationship between corruption and cash holdings is weaker in countries with more efficient judicial systems. These results are more noticeable in emerging economies, where legal systems are often weaker, reinforcing the agency cost hypothesis and highlighting the importance of institutional quality in corporate financial decisions.