Internal controls, risk management, and cash holdings

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Abstract

Exploiting a unique setting in China where internal controls are intended to manage risks, we investigate how internal controls shape the cash holding policies. Results show that firms with higher internal control quality (ICQ) are less likely to have abnormal cash holdings, either excess or deficit cash, and this effect is not driven by corporate governance quality. We also find that firms with higher ICQ are more likely to increase dividend payments and are less likely to increase M&A investments, especially when the firms have had a negative experience with prior M&A investments. Furthermore, our tests on the market valuation of cash holdings show that investors place a higher value on cash holdings of firms with higher ICQ. Collectively, our findings suggest that internal controls help companies shape reasonable cash policies that lead to value creation.