Cash and corporate control

The takeover market is often suggested as appropriate for containing the agency problems of excessive corporate cash holdings. However, recent studies report con-tradictory evidence. I focus on the takeover-deterrence effects of corporate liquidity and suggest the proxy contest as an effective alternative control mechanism. I find that proxy fight targets hold 23 % more cash than comparable firms, and that the probability of a contest is significantly increasing in excess cash holdings. Proxy fight announcement return also is positively related to excess cash. Following a contest, ex-ecutive turnover and special cash distributions to shareholders increase, while cash holdings significantly decline. QUITE OFTEN, THE TAKEOVER MARKET is suggested as ideal for containing the agency problems of corporate free cash flow. Contrary to this, however, Harford (1999) and Pinkowitz (2002) both find that the likelihood of a firm becoming a takeover target is significantly negatively related to the holding of excess cash. This result could be explained in terms of the takeover-deterrence effects of corporate liquidity. Excess cash enhances the ability of a hostile target to defend itself against an unwanted bid. Such defenses include repurchasing stock, acquiring a competitor of the bidder and filing private antitrust litigation, or turning around to acquire the suitor itself (Bagwell (1991), Stulz (1988), and Dann and DeAngelo (1988)). In addition, excess cash increases the bidder’s uncertainty about the value of the target since it can be used to engage in bidder-specific negative net present value activities. Thus, holding excess cash may serve as a deterrent to would-be bidders. This paper focuses on the takeover-deterrence effects of excess cash and suggests the proxy contest as an effective control mechanism for addressing the agency problems of excessive corporate liquidity. As in a hostile takeover situation, management will employ all available defenses in a proxy contest. Nevertheless, I propose that dissident shareholders conducting a proxy fight independently of a takeover bid are not encumbered by the considerations that may deter a hostile bidder