Determinants of Cash Holdings in Multinational Corporation's Foreign Subsidiaries: US Subsidiaries in China

• Published date: 01 March 2017
• Author: Christof Beuselinck,Yan Du
• Date: 01 March 2017
• DOI: http://doi.org/10.1111/corg.12176

Determinants of Cash Holdings in Multinational

Corporation’s Foreign Subsidiaries: US

Subsidiaries in China

Christof Beuselinck and Yan Du*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Weexamine determinants of cash holdingsin Chinese subsidiaries of US multinational corporations

(MNCs), a setting where growth opportunities make cash holdings desirable for investment opportunities but also vulnerable

to potential expropriation because of poor investor protection.

Research Findings/Insights: We show that headquarters accumulate larger cash holdings in foreign subsidiaries with locally

registered patents and in foreign subsidiaries operating in the same industry as corporate headquarters. Further, foreign cash

holdings are higher when these are safeguarded by a subsidiary board. Moreover, the effect of shared industry on subsidiary

cash holdingsis larger when a board is installed in the subsidiary.Finally, thepositive relation between a subsidiary’s capability

to innovateand to transfer knowledgeand its level of cash holdingsis stronger when the subsidiaryis led by US expatriate CEOs.

Theoretical/Academic Implications: Our results indicate that MNCs accumulate cash in foreign subsidiaries with innovation

and knowledge transfer capabilities. Furthermore, and in line with agency theory, we f‌ind that MNCs safeguard foreign cash

via the installing of subsidiary boards and expatriate CEOs. These f‌indings suggest that the installing of monitoring devices

are crucial in reducing the potential expropriation risk of foreign cash holdings.

Practitioner/Pol icy Implications: Our study highlights the importance of consideringforeign subsidiaries’positions in innova-

tion and in knowledgetransfer when MNCs make decisionson the levels of overseas cash holdings.It offers insights regarding

the importance of subsidiary boards and expatriate CEOs inmonitoring and controlling foreign subsidiaries.

Keywords: Corporate Governance, Cash Holding, Multinational Corporations, Foreign Subsidiary Boards

INTRODUCTION

Multinational corporations (MNCs) hold signif‌icant

amounts of cashin their foreign subsidiaries.According

to the US Federal Reserve, non-f‌inancial US companies had

$1.79 trillion in cash at the end of 2012, 60 percent of which

is “trapped”overseas (Chasan, 2012). Given the importance

of MNCs in the globalization of the world economy, the

debate about how much cash MNCs should hold in their

overseas subsidiaries has become a pivotal discussion point

in international business practice. Academic research has

provided different explanations for why standalone f‌irms

hold cash. However, the cash policies of MNCs remain

underexplored. A notable exception comes from the interna-

tional taxation area (e.g., Blouin, Krull, & Robinson, 2012;

Foley, Hartzell, Titman, & Twite, 2007). These studies suggest

that f‌irms leave more cash in foreign subsidiaries when

repatriation triggers high tax costs. Despite these valuable

insights about reduced tax costs of foreign cash holdings, tax

repatriation costs arguably do not provide the complete

picture for the increasing levels of foreign cash holdings of

US MNCs (Pinkowitz, Stulz, & Williamson, 2016). In the

current study,we investigate other potential(non-tax) triggers

for cash holdings in MNCs’foreign subsidiaries.

Prior researchon cash holdings in standalonef‌irms suggests

that f‌irms holdcash for a transaction cost motive (Kim, Mauer,

& Sherman, 1998; Miller & Orr, 1966; Mulligan, 1997; Opler,

Pinkowitz, Stulz,& Williamson, 1999; Ozkan & Ozkan, 2004)

and a precautionary motive (Bates, Kahle, & Stulz, 2009;

Han & Qiu, 2007). In addition, strategy scholars view cash as

a strategic asset that enables f‌irms to pursue innovations and

respond to environmental uncertainty (George, 2005; Kim &

Bettis, 2014; O’Brien & Folta, 2009). The amount of cash

holdings is also inherently determined by the shareholder–

manager agency problem. Despite relevant insights into cash

holdings for standalone f‌irms and recent insights into tax

factors explaining MNC foreign cash holdings, there are only

scarce insightsinto other factors that may explain MNCover-

seas cash holdings. Recently, a couple of studies investigate

the determinantsfor MNCs’cash holdings at the consolidated

*Address for correspondence: Yan Du, EDHEC Business School, 24, Avenue Gustave

Delory –CS 50411,59057 Roubaix Cedex 1, France; Tel: + 33 3 20 15 45 00; Fax: + 33 3

20 15 45 01; E-mail:yan.du@edhec.edu

© 2016 JohnWiley & Sons Ltd

doi:10.1111/corg.12176

100

Corporate Governance: An International Review, 2017, 25(2): 100–115

level (Duchin, 2010; Pinkowitz et al., 2016) and the impact of

multinationality on corporate cash holdings (Ramírez &

Tadesse, 2009). In the current paper, we complement this

stream of research by investigating the determinants of

MNC cash holdings at the foreign subsidiary level.

More specif‌ically, drawing upon a network theory of the

MNC and agency theory, we argue that MNCs face a funda-

mental tension, which inf‌luences the amount of cash that is

put under the control of subsidiary managers. This tension

arises from two unique characteristics of foreign subsidiaries

as an organizational form. First, by nature an MNC consists

of a network of geographically dispersed and interdependent

organizations (Ghoshal & Bartlett, 1990). The competitive

advantage of MNCs is derived from their ability to transfer

and utilizeknowledge across borders(Gupta & Govindarajan,

2000). Cash holdings at the subsidiary level may facilitate

foreign subsidiary’s capabilities to create and transfer

knowledge, which in turn delivers value for the MNC.

Second, the international aspect of MNCs indicates that

headquartersface diff‌iculties in observing and/or monitoring

the foreign subsidiary operating in a different host country

(Nohria & Ghoshal, 1994; Roth & O’Donnell, 1996). Conse-

quently, leaving signif‌icant amounts of cash abroad is risky,

because that money can be subject to ineff‌icient use, and in

an even worse scenario, may ultimately be expropriated.

Therefore, there is a fundamental tension between the value

of delegating decision-making authorities to foreign subsidi-

aries (as evidenced by the amount of subsidiary cash) and

the need for safeguarding foreign cash.

Combining research on the role of subsidiaries in the MNC

network with the agency perspective, we argue that the need

for delegating decision-making authorities to foreign subsidi-

aries (as evidenced by the amount of subsidiary cash holding)

may vary across conditions. For instance, when a foreign

subsidiary generates technology in the local country (e.g.,

via locally developed and registered patents), headquarters

may feel the need to leave cash in the foreign subsidiary to

prevent the loss of underinvestment. Or alternatively, when

a foreign subsidiary is established to transfer headquarters

knowledge to local markets, such as when subsidiaries oper-

ate in the same industry as corporate headquarters (Alfaro &

Charlton, 2009; Fang, Wade, Delios, & Beamish, 2013), it

may be given more f‌lexibility to build up its own cash piles.

Furthermore, we expect the need for safeguarding foreign

cash to be greater when cash is delegated to foreign subsidi-

aries with innovation capabilities (i.e., patents) and foreign

subsidiaries operating in the same industry as headquarters.

We therefore argue that MNCs are willing to accept high

levels of cash holdings in these foreign subsidiaries when

monitoring devices (e.g., subsidiary boards; expatriate CEOs)

are installed, which reduce the risk that subsidiary managers

use the cash to pursuetheir personal interests.

To tackle our research question, it is essential to observe a

setting where growth opportunities encourage cash holdings

for strategic investment opportunities but where the same

cash holdings are vulnerable to potential expropriation with-

out the presence of appropriate monitoring devices. China is

a potentially fruitful setting to study this research question

for three principal reasons. First, China is a booming market

with high growth opportunities and where many MNCs

make strategic investment decisions. Suff‌icient cash levels

may be prerequisite for an MNC to react quickly and

adequately to local business opportunities, especially in

high-growth markets. Second, corporate governance mecha-

nisms in China are underdeveloped (Wei, Xie, & Zhang,

2005) and the institutional environment is characterized by

concentrated ownership structures, relationship-based

business networks, insider control, and high levels of govern-

mental power and political inf‌luence (e.g., Chen, Chen,

Schipper, Xu, & Xue, 2012; Claessens, Djankov, & Lang,

2000). Thesefactors provide subsidiarymanagers with greater

f‌lexibility to pursue their own interests in the absence of

monitoring devices. Finally, by selecting subsidiaries from a

single hostcountry such as China, we are able to hold constant

the country-level legal setting and keep the tax incentive of

foreign cash holdings constant. This allows us to identify the

drivers of cash holdings that extend beyondthe well-explored

taxation arguments (e.g., Foley et al., 2007). We study US

MNCs because prior literature has shown that the relatively

strong US corporategovernance may spill over across borders

when US investors take on foreign equity stakes (Aggarwal,

Erel, Ferreira, & Matos, 2011; Oxelheim & Randøy, 2005). This

identif‌ication strategy allowsus to explore how MNCs choose

the location and control of foreign subsidiary cash, particu-

larly in a foreign setting where the risk of expropriation is

substantial, as is the case in China. In order to maximize the

number of parent–subsidiary observations under a single

parent and single subsidiary country perspective, we select

US MNCs because the foreign direct investment (FDI) posi-

tion of the US in China has been historically high. Finally,

our empirical analyses are based on 371 subsidiaries (1,395

subsidiary f‌irm-years) aff‌iliated with 160 US MNCs with

activities in China during the period 2001–2010.

Tothe best of our knowledge, this study is the f‌irst to jointly

examine the inf‌luences of subsidiary characteristics and f‌irm-

level monitoring devices on MNCs’overseas cash holdings.

In addition to combining the international business with cor-

porate governance literatures, we contribute to the literature

in several ways. For the international corporate governance

literature, research has shown that relatively strong

Anglo-American corporate governance may spill over across

borders. For example, Aggarwal et al.(2011)f‌ind that US

institutional investors taking on foreign equity stakes play a

role in promoting governance improvements outside of the

US. Similarly, Oxelheim and Randøy (2005) suggest that the

Anglo-Americancorporate governancesystem has a strong ef-

fect on governance of non-Anglo-American f‌irms via the cap-

ital market(cross-listings in Anglo-American markets)and the

marketfor corporate control (Anglo-American boardmember-

ship). Our study complements this research by investigating

how US MNCs safeguard their foreign cash via the installing

of monitoring devices, particularly ina foreign setting where

the risk of expropriation is substantial, as in China.

Moreover, our study focuses on the functionalism of the

subsidiary board, a structural mechanism available to MNCs

to monitor their foreign subsidiaries. Our results suggest that

foreign subsidiaries hold more cash in the presence ofsubsid-

iary boards, and the effect on subsidiary cash holdings is

larger when a board is installed in a subsidiary operating in

the same industry as corporate headquarters. Given that US

MNCs’foreign subsidiaries in China are not legally obliged

to have a subsidiary board, our f‌indings suggest that when

101MNCS’FOREIGN CASHHOLDINGS

© 2016 JohnWiley & Sons Ltd Volume 25 Number 2 March 2017