A Tide of Cash: Corporate Governance and the Management of Large Cash Windfalls

In this paper we revisit the contentious issue of whether corporate governance arrangements influence corporate cash holdings. We use the exogenous cash windfalls in the oil industry during the 2000s to test the power of three governance dimensions (managerial entrenchment, board independence and ownership) in explaining differences in cash management policies. Between 2000 and 2008 the oil price successively reached new record levels, and by 2008 its yearly average had increased by more than 200% compared to the 2000-2003 period, resulting in substantial cash windfalls in oil firms. We document that firms with a classified board have higher cash holdings. They also return less money to shareholders through share repurchases and have lower investment rates. Importantly, the tendencies to underinvest and withhold share repurchases got stronger over time as the cash windfalls materialized in the industry. In the years 2007-2008, when oil prices and share repurchases peaked, firms with a classified board engaged less in repurchases and increased cash holdings compared to other firms. Classifiedboard firms also exhibit a higher cash-sensitivity to lagged windfalls. Overall, the analysis in this paper provides strong support for the managerial risk aversion-theory of excess cash holdings, and suggests that a classified board is the key governance-characteristic associated with a conservative cash management policy.