Abnormal cash holdings and the cost of equity capital

This study examines the implications of abnormal cash holdings on the cost of equity capital. We find the positive relation between abnormal cash holdings and the cost of equity capital, suggesting investors require the higher cost of equity capital for firms having abnormal cash holdings. Specifically, while both insufficient and excess cash holdings are positively related to the cost of equity capital, the effect of insufficient cash holdings on the cost of equity capital is stronger than the effect of excess cash holdings. Further, the positive relation is more pronounced for firms with high information asymmetry among investors, suggesting that the informational role of abnormal cash holdings is more significant for firms with poor information environment. Overall, our empirical evidence supports that investors recognize abnormal cash holdings, both insufficient and excess cash holdings, as the value relevant signals in determining the cost of equity capital.