Impact of excess cash on earnings management and firm value: Evidence from China

This study examines how excess cash drives earnings management and firm value in China. Using a fixed effect panel regression on a sample of 12,629 observations covering 300 firms listed in the Shanghai Stock Exchange, we find that excess cash has a positive impact on firm value confirming pecking order theory. Our results show that earnings management has a negative impact on firm value in China, which supports the efficient earnings management view. We find that managers in Chinese firms are less likely to use excess cash for manipulating earnings. We provide empirical evidence that firms with excess cash seem to use it more for precautionary purpose than earnings management and the excess corporate liquidity of Chinese firms is used for value-enhancing activities. The test of robustness using the Instrumental Variable (IV) model confirms the results of the study. Our study merges two areas of corporate finance by incorporating agency problems concerning earnings management and cash holdings.