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Running head: ARTICLE REVIEW 0

Cash and Corporate Control: An Article Review

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Overview

In an article titled Cash and Corporate Control, Olubumni Faleye (2004) asserts that the takeover market is normally considered to be recommended for containing the agency challenges of excessive corporate cash holdings. Nonetheless, some of the most contemporary research provides contrary evidences. As such, Faleye (2004) focuses his attention on the takeover-deterrence impacts of organizational liquidity and maintains that the proxy contest is an effective option in terms of a control mechanism. The author also determines that the proxy fight is directed at 23 percent more cash than the comparable organizations, and that the possibility of a competition is significantly rising in excess cash holdings. Furthermore, Faleye (2004) indicates that proxy fight announcement return is also positively associated with excess cash. After a context, the executive turnover and special cash that is distributed to all the stakeholders rise in terms of amounts, whereas the cash holdings often reduce by a significant degree.

Faleye also suggests that in many situations, the takeover market is indicated as recommended for containing the agency challenges of organizational free cash. Nonetheless, Harford (1999) takes an entirely different position. To Harford and Pinkowitz, the possibility of an organization to become a takeover target is majorly negatively associated with the holding of surplus cash. This outcome might be comprehensively understood with respect to the takeover-deterrence of excess cash. According to Fayele’s argument, surplus cash provides the capacity of a hostile target to protect itself against an undesired bid. These kinds of protections are inclusive of repurchase of stock, acquisition of a competitor of the bidder, as well as the filling of private antitrust litigation. Further, it may include the turning around to acquire the suitor itself. Moreover, the surplus cash raises the bidder-specific negative net that is the present value activities. This implies that the excess cash can act as a deterrent to would-be bidders.

Review of the Article

In this article, Faleye (2004) focuses his attention on the impacts of corporate liquidity and views the proxy contest as an effective option control mechanism. From the study carried out by Faleye (2004), the proxy fight target holds 23 percent more cash than the comparable organizations, and that the possibility of a contest is significantly rising in excess cash holdings. In light of the above study, it can be said that the value o cash holdings is of importance to an organization. The stockpiles of cash are often value decreasing. Thus, their existence offers an external acquirer with a source of gains to an acquisition. Thus, the hanging cash flow theory is predictive of the fact that, compared to otherwise same organizations, the cash-rich company needs to be the prime target within a control contest.

In the event that the response from the market for corporate control is absent, the shareholders have the task of projecting a valuedeclining trait by stockpilers. Such a knowledge would make them adjust the stock price accordingly. Nonetheless, in case such stockpiles are valuable reserves that are accumulated in advance of a value-rising investment, then there must be no such association. This phenomenon is regarded as a negative relationship, often between cash and the probability of being an acquisition target between the accumulation of cash and the stock price reactions, while it needs to be positive within the optimal savings hypothesis.

Faleye’s suppositions can best be understood with the use of the free cash flow theory, which projects that cash-rich organizations are likely to be poor bidders. One important strategy that can be derived from Faleye’s article is that such organizations have the task of ensuring that they do not make systematically worse investment decisions than organizations that are disciplined by the outer capital markets. Even in the absence of serious agency challenges, a weaker kind of free cash flow model can still result in less valuable acquisitions through cash-rich organizations. Therefore, by getting rid of the outside monitoring procedures from the acquisition decisions, the capacity to internally finance minimizes the due-diligence that is undertaken prior to the actual investment. From the foregoing, the flexibility and independence that the cash reserves offer simply make it easier to make a mistake. Therefore, the acquisitions that are planned within the optimal savings hypothesis need not to be distinct from others.

In view of the above, Faleye (2004) enhances the reader’s understanding of the efficacy of external control in containing the excess liquidity challenges and the specific ways in which excess cash are disgorged. On top of that, Faleye’s article offers a systematic evidence of the significance of specific agency issues in exerting impacts on the occurrence of a proxy fight. Therefore, when dissidents declare a proxy conflict, they are not merely focused on the entire picture as shown in the stock performances or earnings. Rather, they are focused on specific issues that are associated with the management’s control of an organization. Most significantly, the above article offers extra proof relating to the effectiveness of the company as an economic institution. In as much as the management team is entirely free to take necessary steps without being interrupted by their key shareholders, and are capable of employing several devices to safeguard its interests, the degree to which it can take part in non-value-improving initiatives is restricted by control mechanisms such as the proxy contests. Finally, Faleye (2004) reviews the previous literature on the agency matters that stem from the excess liquidity, the corporate control implications of such matters, and his motivations for carrying out the study. For instance, the writer states that cash flow needs to be paid out to the organization’s stakeholders because the corporation cannot invest it profitably on their behalf.

References

Faleye, O. (2004). Cash and corporate control. The Journal of Finance, 59(5), 2041-2060.