The effects of financial constraints on the market value of cash in a mandatory dividend context

This article aims to shed light on the effects of financial constraints on the value shareholders attribute to cash holdings in firms listed on the Brazilian stock exchange, where corporate law determines that publicly listed companies set aside part of their annual profits for dividend payments. While prior empirical literature provides evidence that cash holdings are more valuable for financially constrained companies than for their unconstrained counter parts, we cannot support the hypothesis that the market value of cash increases as obtaining access to external funds becomes more difficult. Our analysis also reveals that constrained companies do not hold significantly higher cash savings than their unconstrained peers. This last result, in turn, is not in line with the precautionary motive for having cash. Moreover, although the principal argument for adopting mandatory dividend rules in Brazil was to increase the protection of minority shareholders, we observe that the contribution of cash holdings to firm value is still small in Brazil, especially in dual-class companies, because investors expect cash holdings to be partly consumed as private benefits due to the presence of significant agency problems. This research is relevant because it serves as an additional step in understanding how a legal mechanism established by a government to protect investors affects the contribution of cash holdings to firm value. Governments that intend to adopt mandatory dividend rules to safeguard the cash-flow rights of minority shareholders can use our findings to make better decisions regarding whether to enforce compulsory dividend payments.