The Impact of Investment, Debt, Macroeconomics and Diversification

Strategy on the Influence of Cash Management on Firm Value

R. Heru Kristanto H. C., Agung Satmoko, and Sri Isworo Ediningsih

Universitas Pembangunan Nasional Veteran Yogyakarta

Keywords: Cash, Firm Value, Investment Policy, Debt Policy, Diversification

Abstract: The management must allocate cash on a level that could maximize the wealth and marginal benefits of cash

holding. The company with flexible financing when facing a negative shock could avoid financing difficulties

and could provide funds for investment purposes when the shareholders and cash allocation strategy, which

balanced the cost opportunity to invest, arose. Cash management is reinforced by investment policies, debt

policies, stable macroeconomic conditions, and an appropriate diversification strategy. Good cash

management will increase company value. The purpose of this paper is to explain the effect of cash

management on firm value and to analysis moderate factor investment, debt, macroeconomics, diversification.

INTRODUCTION

Cash is a highly liquid asset and can be utilized

immediately to fulfill the requirements of the

company's activities. The cash is cash included in the

current assets category. The optimal cash holdings are

cash that must be maintained by the company, thus

not become a surplus or deficiency, and a

predetermined limit should provide it. Cash holdings

are cash required to fulfill daily operational activities,

and it can also be used for several things, i.e., to be

distributed to the shareholders in the form of cash

dividends, to buyback the required share, and for

other sudden requirements. Cash can be defined as a

set that can be likened with cash and assets that will

be immediately turned into cash, such as financial

receivables and securities that will mature soon (Gill

and Shah, 2012). The studies of cash have been an

important part of the financial literature since cash

holdings may increase or decrease the firm value.

Along with rapid and diversity business

development, the business growth and development

process needs options on sufficient cash or a high

level of financial flexibility. Financial managers are

expected to have flexible financial policy priorities

and handling financial distress issues. Several studies

find that the amount of cash ranges from 8% to 10.5%

(Kim, et.al, 1998; Opler, et.al, 1999; Foley, et.al,

2007; D'Mello, et.al, 2008; Bigelli and Sancez, 2012).

The amount of cash in several ASEAN countries,

including Thailand, Indonesia, Philippines,

Singapore, and Malaysia, is 12% from 2001 to 2005

(Da Cruze, 2015). In Indonesia, the ratio of cash

holdings on assets for non-financial companies from

2001 to 2018 ranges from 7.0% to 9.1% (Kristanto et

al., 2019). The business internationalization,

integration of financial market, hyper-competitive,

and business growth opportunities require financial

flexibility to be able to join the competition

successfully.

In theoretical and empirical studies, cash remains

a controversy, in which the use of large cash will also

bring large benefits and capital costs. Empirical

studies generate mixed findings, both for its effects

on firm value and the interaction of various factors

contributing to the relationship between cash and firm

value. Keynes (1936) states that there are three

motives of the company to hold cash, namely: the

transaction motive, anticipation motive, and

speculation motive. Several empirical studies find a

positive relationship of cash and firm value

(Pinkowitz et al., 2003; Saddur 2006; Fresard 2010,

Kalcheva and Lins, 2007; Loncan, TR, and Caldeira,

JF, 2014, Tingting Zhou, 2014).

Various empirical studies find evidence of a

negative relationship between cash and firm value.

The companies with high financial liquidity, large

cash tend to have large overinvestment, opportunism

problems, agency problems, private benefit, and cost

of capital as well. A number of empirical studies find

a negative relationship of cash and firm value (Luo

and Hachiya, 2005; Oler and Waegelein, 2011;

Huang et al., 2013; Anabestani and Shourvarzi, 2014;

Abushammala and Sulaiman, 2014; Tingting

330

H. C., R., Satmoko, A. and Ediningsih, S.

The Impact of Investment, Debt, Macroeconomics and Diversiﬁcation Strategy on the Inﬂuence of Cash Management on Firm Value.

DOI: 10.5220/0009965803300336

In Proceedings of the International Conference of Business, Economy, Entrepreneurship and Management (ICBEEM 2019), pages 330-336

ISBN: 978-989-758-471-8

Zhou, 2014; Yahyazadeh et al., 2014; Yueh-ErJi

et al., 2012). The relationship may be positive or

negative based on the type of the company and

different settings as well (Amman et al., 2011;

Dittmar and Mahrt-Smith, 2007; Drobetz et al., 2010,

Tong, 2011).

The increase in debt will increase the interest

expense that must be borne by the company. If the use

of debt is used for investment with a positive NPV,

then the value of the company will increase (Husnan,

2012; Hanafi, 2014. The high investment will

increase agency problems and also decrease the value

of the company in the long run (Kristanto et al.,

2019). Operational conditions are not only influenced

by internal conditions or the ability to manage

working capital from within the company but also

influenced by external conditions, macroeconomic

conditions such as interest rates, inflation, GDP,

currency exchange rates, and other external

conditions (Lay, 2012; Nguyen and Ngo, 2014;

Carvajal, 2015; Hanafi, 2016) Diversification

strategies can increase cash receipts but can also

decrease cash (Harford et al., 2008)

This paper investigates the effect of cash and firm

value. To analysis the moderate factor in the effect of

cash and firm value. The prediction of moderating

factors is investment policy, debt policy,

macroeconomics, and diversification strategy. The

remainder of the paper is organized as follows.

Section 1 introduction. Section 2 presents the

literature and hypothesis development. Estimation

method. Section 3 or conclusion.

LITERATURE REVIEW

In the management of current assets, the company

encounters a fundamental trade-off between working

capital (liquidity) and profit (profitability) resulted.

The working capital is needed to run the business, and

the bigger the working capital, the smaller the risks

for fund deficiency, thereby lowering the operating

risks of the company. Nonetheless, holding working

capital requires costs. For instance, if the inventory is

overly big, the company will have assets that will

yield zero or negative returns, in case the costs for

saving and damage are high. In addition, the company

must obtain capital to purchase assets, such as

inventory, and this capital has costs. Thus profits

might decrease due to surplus in assets (inventory,

accounts receivable, or even cash). Thereby, there is

pressure to hold working capital at a sufficient

minimum amount in order to support smooth business

operations (Brigham & Houston, 2001; Hanafi,

2014).

The management of working capital is one of the

significant matters when it comes to discussing

liquidity and profitability issues (Eljelly, 2004) that

involve decisions on the amount and composition of

current assets as well as the funding. The larger the

proportion of current assets, the smaller the risks for

running out of cash. In the opinion of Raheman and

Nasr (2007), in order to reach the optimal

management of working capital, the company's

managers must be able to control the trade-off

between maximizing the profitability and accuracy of

the liquidity. The optimal working capital

management is expected to contribute positively

towards the creation of firm value (Howorth &

Westhead, 2003).

Cash is the most liquid form of assets that are

commonly used right away to meet the financial

obligations of the company. Due to its illiquid nature,

cash provides the lowest benefit. Therefore, the main

problem of cash is to provide adequate cash; hence

the liquidity won’t be hampered (Husnan 2011,

Hanafi, 2014). The cash management using Boumol

model (1952) identifies that cash requirement should

have balance; hence it does not become too high or

too low or employing a model similar to inventory.

Meanwhile, the cash management with Miller and

Orr model uses the determination of the upper and

lower limit of cash balance.

The theme cash initially becomes an object of

study in the academic field proposed by Keynes

(1936). The cash studies are later developed with

various approaches, such as agency problem (Jensen

& Meckling, 1986; Jensen, 1986), liquidity level,

trade-off theory (Miller and Orr, 1966; Opler et al.

1999), pecking order theory (Ferreira and Vilela,

2004), agency theory approach (Bates, Kahle and

Stulz, 2009).

HYPOTHESIS DEVELOPMENT

Damodaran (2006) also explains that the function

and goal of the company are to maximize the firm

value, associated with three financial decisions of the

company, namely investment, financing, and

dividend decisions. In the science of finance and

managerial, Opler, Pinkowitz, Stulz and Williamson

(1999) and also intuition model by Miller and Orr

(1996) use cash management model by comparing the

benefits and costs of cash holding to identify the

optimal level of the company liquidity (trade-off

model). Pecking order theory reveals that the

optimum level of the amount of corporate cash has

manager preferences functions by using internal

resources to reduce transaction costs and asymmetric

information. The study related to cost-benefit and

The Impact of Investment, Debt, Macroeconomics and Diversiﬁcation Strategy on the Inﬂuence of Cash Management on Firm Value

331

liquidity, having a positive impact on company

performance, was undertaken by Pinkowitz et al.

(2003), Fresard (2010). The empirical studies find a

positive relationship between cash holdings and firm

values, Kalcheva and Lins, 2007; Loncan, TR and

Caldeira, JF, 2014, Zhou Tingting, 2014). Several

studies in various countries, such as USA, Taiwan,

Malaysia, Australia, Sweden, Pakistan were

conducted by Smith (2014), Rashid (2014), Al

Dhamari and Kun Ismail (2014), Darush Y and

Ohman (2014), Azmat (2014), Tae-nyun Kim (2013),

Huang et al. (2014), Calendro (2015). The research

results conducted by those researchers indicate that

the cash holdings of the company have a positive

relationship with the firm value in various sizes or

proxy. Companies should allocate the cash holding of

the company at a normal rate, in which at the level,

the cash holding is used to maximize the wealth of the

shareholders, and not only to maximize the wealth of

the managers, management, or controlling

shareholders. The cash holdings which are beyond

normal or excess cash should be used for the

investments having positive NPV.

Hypothesis 1. Cash has a positive effect on firm

value.

The company's investment decisions are much

affected by investment opportunities that are

profitable or expected to be positive NPV. With

predictions of profitable investment, the management

will commonly conduct investments by arguments to

maximize the wealth of the company's owners and

having managerial motivation. The benefits of having

cash reserves, sufficient cash holdings are related to

risks and avoid the existence of underinvestment.

Following the free cash flow hypothesis developed by

Jensen (1986), a variety of empirical studies have

found the relationship between free cash flow,

overinvestment, and decreased performance. From

the study, it is found that companies having cash

surplus and free cash flow tend to make an excessive

investment (Dechow et al. 2005), and even when the

company faces lower investment opportunities (Opler

et al. 1999). Other

researchers also find that companies having a

large amount of cash are likely to make acquisitions

that will be followed by a decrease in operating

performance (Harford 1999). Lau and Block (2012)

also find that the operating performance of the

companies in the future will be lower in companies

doing investment spending, and this negative

relationship is going stronger if there is abundant free

cash flow.

If there is a profitable investment opportunity, the

management will invest. If the company does not

have financial constraints, and there is ease of access

to capital markets, the company will find it easier to

adjust to its financing. The companies that are not

constrained by financial or funding will demonstrate

high firm value (Fama and French, 1992). The

companies that have difficulties in financing to make

profitable investments are generally using or more

depending on internal funding, i.e., cash flow and

cash holdings. Companies with limited access

conditions, to avoid themselves from

underinvestment, and for improved performance

generally have great cash holdings (Han and Qiu,

2007).

Hypothesis 2. Investment policy strengthens

the effect of cash on firm value.

Financing mix describes the company in making

decisions regarding funding, whether to use short-

term debt, long-term debt, or equity. The funding

includes short-term and long-term funds, in which the

short-term is defined as the funding less than a year

or less than one business cycle, while the long term is

more than one business period (Hanafi and Halim,

2009).

Debt represents the corporate governance

mechanism, where it affects the business efficiency

and generally affects the success of the company

(Jensen, 2000; Mahrt-Smith, 2005). Debt has

advantages, particularly in tax savings or tax-

deductibility of financial expense, to improve

managerial discipline, and to minimize the costs

caused by asymmetric information. In addition to

those advantages, debts also have costs, namely the

increasing probability of bankruptcy, managers'

opportunism, and the majority of shareholders by

substituting the costs on creditors and reduced

financial flexibility.

Graham and Harvey (2001) identify the potential

effects of debt using opportunism problems of

managers and financial flexibility, which will tend to

interact with cash holdings of the company. Debt has

a complementary role in the company's liquidity. The

companies with a large debt level will

Increase the conflict of interest among the

managers, shareholders, and creditors, which is

preceded by the opportunism behavior of the usage of

the company's liquidity. Increased debt will bring

forth agency problems and have negative

implications for the cash holdings. The companies

with a large debt level will increase the financial

distress and possibilities of bankruptcy, thus the cash

holding to be more careful and efficient. Debt will

give a positive signal of the benefits of cash holdings

usage to increase the company's value.

During company growth, the cash holdings are

increasing; thus, the needs for debt funding tend to

shift the internal funding. If the growth of the

company is highly at risk, it will increase financial

distress implying on debt reduction (Frank and Goyal,

2009). Guney et al. (2007) reveal substitution effects

between debt and liquidity. During debt at a low level,

ICBEEM 2019 - International Conference on Business, Economy, Entrepreneurship and Management

332

it will bring negative effects on the liquidity, while

debt at a huge level positively affects liquidity. The

research by Faulkender and Wang (2006) shows that

at the high debt level, the company's liquidity will

decline. The cash holding has a tendency affecting the

firm value and interacting with the capital structure.

Hypothesis 3. Debt policy strengthens the effect

of cash on firm value.

Datta et al. (1991) imply that diversification as the

level of diversification (degree of diversification)

concerning the breadth of the level where the

company diversifies itself into different businesses,

products, or markets. Bettis & Mahajan (1985) define

that level of business diversification is diversified

types of businesses, either related or unrelated.

Meanwhile, Ramanujam & Varadaran (1990) define

diversification as the company's entry into the line of

new business activities via internal business

development and acquisitions.

The company chooses to conduct diversification

in facing fierce competition and increasingly rapid

market growth, as triggered by revolution and

globalization. David (2003) asserts that the

development of a new business that is different from

the existing business and involving several

investments is called diversification. When a

company chooses to diversify its operations from one

into several industries, it is implied that it is

conducting strategies to incorporate level (Hitt et al.,

2011: 158-159). The company conducting

diversification has a goal to expand its business by

opening several business units or new subsidiaries,

both in the already-existed similar business

line(related) and in the different business units with

core business (unrelated).

Studies on diversification and its effect on firm

value are still being debated, whether the

diversification can bring benefits or even bring

negative impacts on the firm value. The studies

suggesting that diversification increases the firm

value: 1) the increase in profitability is higher on

average for companies conducting related

diversification compared to the non-diversified

companies (Amit and Livnat, 1988; Rumelt, 1974;

Aisjah, 2009). 2) the diversification done by the

company does not decrease the firm value (Gomes &

Livdan, 2004). 3) the interaction of the diversification

effects on technology diversity (Miller, 2004, 2006).

4) the presence of international diversification does

not destroy the firm value (Santos et al., 2008). 5) the

diversification has positive effects on the

performance of companies in Indonesia (Chakrabarti

et al., 2007).

Duchin (2010) researched the company's cash

holdings and the relationship with the diversification

of company divisions. This research reveals that

companies with a diversified division have lower cash

holdings compared to those having no diversified

divisions. Duchin (2010) also mentions that there is a

relationship between financial difficulty and its

relationship with corporate governance and its

relationship with an investment opportunity if it is

associated with company diversification and the

company cash holdings. The significant

diversification has implications on the company

management, where it will give rise to costs trade-off

and benefits, as well as the effects on the number of

cash holdings of the company.

Hypothesis 4. Diversification strengthens the

effect of cash on firm value.

The advantage of cash holding is very relevant in

a particular period in which the macroeconomic

conditions are fairly well. In fact, when using external

funding, many companies need high costs or difficult

to pay due to constrained access to capital markets or

because of the economic crisis. Companies tend to

raise cash holding when access to the capital markets

is difficult or when there is an economic recession

(Adjei, 2011).

Economic conditions would influence the

implication of the amount of companies' cash

holding. Risks arise because of uncertainty. The

company faced a lot of uncertainties and led to the

emergence of the risk. Changes in the interest rate can

cause the company to face two types of risk, namely:

a) the risk of changes in the level of income, which

is net income (investment result minus costs),

changes or reduces than expected, b) the risk of

changes in market value due to changes in interest

rates. And so do the changes in currency exchange

rates against the currencies of other countries. The

currency of a country is a reflection of the economic

conditions of a country. If the economy of a country

improves, then the country's currency tends to rise

against the currencies of other countries (Hanafi,

2014).

Some research in various countries indicate that

macroeconomic conditions influence the

performance of the company or the company's stock

price (Kim Hiang Liow, Muhammad Faisal Ibrahim,

and Huang Qiong, 2005; Anthony Kyereboah-

Coleman and Kwame F. Agyire-Tettey, 2008);

Catalina Granda Carvajal, 2015; Tho Nguyen and

Ngo Chau, 2014; Hassan Tanha, Michael Dempsey,

and Terrence Hallahan, 2014). Research by Adjei

(2011) found out that the company's performance

significantly decreases at the start of the economic

crisis. Large-scale companies undergo declining

performance and tend to have a low cash holding and

high short-term debt. The company can be stated to

have limitations in funding or company operations

that highly depend on external funding. Cash holding

facilitates companies in the liquidity or the company's

position and reduces the likelihood of bankruptcy

The Impact of Investment, Debt, Macroeconomics and Diversiﬁcation Strategy on the Inﬂuence of Cash Management on Firm Value

333

during the crisis. At the time of the financial crisis,

the company experiences a decline in cash flow, and

the company provides payment for investment

projects with a cash reserve and is likely to add debt

or issuing new shares to maintain the equilibrium of

business. Research by Faulkender (2006), Acharya

(2007), Denis and Sibilkov (2010), Fresard (2010)

Duchin (2010) found that there is a negative

correlation between the economic crisis and external

funding that reduces the company's investment and

low cash holding company.

Hypothesis 5: Macroeconomics to moderating

the effect of cash on firm value.

CONCLUSIONS

In theoretical and empirical studies, cash remains

a controversy, in which the use of large cash will also

bring large benefits and capital costs. At the

theoretical level, the positive effects of cash and

anticipation motives. Cash in the view of the

contemporary has strategic value and is important for

the company. The policy in determining the amount

of cash holding in the company may affect the firm

value (Opler et al., 1999; Power & Baker, 2010). The

sufficient cash will give the flexibility to avoid the

costs emerging from the underinvestment.

The company with sufficient funding will be

capable of facing funding shock, avoiding financial

difficulties, and providing funds for investment needs

in the event of investment opportunities. Studies in

several countries yield mixed findings on the

relationship between cash and firm values. It is

indicated that the relationship between cash and

increased firm value is affected by numerous

important variables, namely, investment policy, debt

policy, macroeconomics, and strategies

diversification of the company.

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