Unemployment insurance and cash holdings of privately held firms around the world

• Date: 01 July 2020
• Published date: 01 July 2020
• DOI: http://doi.org/10.1111/corg.12318

ORIGINAL ARTICLE

Unemployment insurance and cash holdings of privately held

firms around the world

Marc Deloof

1,2

| Yan Du

1

| Tom Vanacker

3,4

1

Department of Accountancy and Finance,

University of Antwerp, Prinsstraat 13, 2000,

Antwerp, Belgium

2

Antwerp Management School, Boogkeers 5,

2000, Antwerp, Belgium

3

Department of Accounting, Corporate

Finance and Taxation, Ghent University, Sint-

Pietersplein 7, 9000, Ghent, Belgium

4

SITE (Science, Innovation, Technology, and

Entrepreneurship), University of Exeter

Business School, Exeter, UK

Correspondence

Marc Deloof, Department of Accountancy and

Finance, University of Antwerp, Prinsstraat

13, 2000 Antwerp, Belgium.

Email: marc.deloof@uantwerpen.be

Abstract

Research Question/Issue: This paper studies the relationship between country-level

unemployment insurance and cash holdings of privately held firms. When public

unemployment insurance is weak, firms may provide alternative unemployment

insurance by committing not to lay off workers in bad times. We hypothesize that

one way firms can do so is by holding larger cash balances.

Research Findings/Insights: Using a large sample covering 388,940 private firms

from 32 countries around the world over the 2007–2014 period, we find a negative

relationship between public unemployment insurance and cash holdings. This effect

is driven by countries where public unemployment insurance is weak or nonexistent.

We also find that privately held firms keep a larger part of their new debt issues as

cash when public unemployment insurance is weak.

Theoretical/Academic Implications: We contribute to a growing literature on an

institution-based view of comparative corporate governance. We show that national

governance factors and, more specifically, public unemployment insurance, which

protects employees (an important but relatively ignored stakeholder), influences firm

cash holdings in a private firm context.

Practitioner/Policy Implications: Our findings have important implications for policy

design. Specifically, they suggest that labor market institutions designed to support

employees can also indirectly benefit their employers because these institutions

allow firms to reduce the opportunity cost related to holding larger cash balances.

KEYWORDS

Corporate governance, cash holdings, privately held firms, public unemployment insurance,

unemployment risk

JEL CLASSIFICATION

G32; G38; J83

1|INTRODUCTION

Firms across the world hold considerable amounts of cash (Dittmar,

Mahrt-Smith, & Servaes, 2003). However, significant cash holdings

increase managerial discretion, which raises concerns about agency

problems (Kalcheva & Lins, 2007). For instance, managers may use

cash to invest in “pet projects”that benefit themselves but do not

create value for shareholders (Shleifer & Vishny, 1997). Moreover,

cash holdings are subject to a high opportunity cost because they

yield low returns (Opler, Pinkowitz, Stulz, & Williamson, 1999). Conse-

quently, a large literature has emerged to increase our understanding

of the firm-, industry- and country-level factors that explain why firms

hold significant cash balances (e.g., Chen, 2008; Dittmar et al., 2003;

Dittmar & Mahrt-Smith, 2007; Frésard & Salva, 2010; Harford,

Received: 20 May 2019 Revised: 3 April 2020 Accepted: 4 April 2020

DOI: 10.1111/corg.12318

188 © 2020 John Wiley & Sons Ltd Corp Govern Int Rev. 2020;28:188–209.wileyonlinelibrary.com/journal/corg

Mansi, & Maxwell, 2008; Kalcheva & Lins, 2007; Kusnadi &

Wei, 2011; Lins, Servaes, & Tufano, 2010; Liu, Luo, & Tian, 2015;

McLean, 2011; Opler et al., 1999; Ozkan & Ozkan, 2004; Pinkowitz,

Stulz, & Williamson, 2003, 2006). However, this influential literature

is characterized by some remarkable gaps that we address in this

study.

First, although privately held firms are the dominant organiza-

tional form across the world, empirical evidence on cash holdings of

private firms remains scarce. Still, privately held firms differ from their

public counterparts in some fundamental ways (Brav, 2009). For

instance, privately held firms generally have lower manager–

shareholder agency problems than public firms because managers and

owners are often the same individuals (Fama & Jensen, 1983). Thus,

private firm managers are less likely to overinvest at the expense of

the owners, which explains why private firms have lower cash bal-

ances than public firms (Gao, Harford, & Kai, 2013). However, because

private firms are more constrained in accessing external capital mar-

kets, they have a higher precautionary demand for cash than public

firms (Brav, 2009). It is further noteworthy that the dearth of research

on cash holdings of private firms usually comes from single-country

studies (Bigelli & Sánchez-Vidal, 2012; Deloof, 2001; Gao et al., 2013;

García-Teruel & Martínez-Solano, 2008; Martínez-Sola, García-

Teruel, & Martínez-Solano, 2018; Orens & Reheul, 2013). Importantly,

however, one can observe some notable differences in the findings

across studies. Such differences suggest that we need more multi-

country studies on cash holdings of private firms, such as ours, to

establish the generalizability of findings from prior single-country

studies.

Second, although differences in samples, time frames, and mea-

sures could explain some of the differences across single-country

studies, an institutional economic perspective (North, 1990) indicates

that differences in countries' national governance systems are also

impactful (e.g., Cumming, Johan, & Zhang, 2014; Cumming, Sapienza,

Siegel, & Wright, 2009). Consistent with this idea, extant research has

started to examine how differences in countries' protection of stake-

holders, including shareholders and creditors, influence firm cash hold-

ings. However, insights on other key stakeholders, such as employees,

are more limited. More recently, there is an emerging literature on the

relationship between different dimensions of countries' labor protec-

tion institutions and cash holdings (e.g., Cui, John, Pang, & Wu, 2018;

Devos & Rahman, 2018; Klasa, Maxwell, & Ortiz-Molina, 2009), but

this literature focuses on publicly traded firms. Despite this focus on

public firms, employees' concerns about losing their job, which would

bring them substantial costs (Agrawal & Matsa, 2013), may be particu-

larly acute in privately held firms. Indeed, private firms are regularly

viewed as less legitimate employers by (prospective) employees rela-

tive to public firms (e.g., Vanacker & Forbes, 2016; Williamson, 2000;

Williamson, Cable, & Aldrich, 2002). Consequently, we need more

insights on how a country's labor protection institutions—particularly

those that affect (prospective) employees' perceived risk of

unemployment—relate to cash holdings in privately held firms.

This paper addresses the abovementioned gaps by focusing on

the relationship between countries' public unemployment insurance—

a specific labor protection institution that reduces the risk of unem-

ployment and the associated loss of wages and other benefits (Ellul,

Pagano & Schivardi, 2018)—and private firm cash holdings around the

world. To do so, we use a large sample covering 388,940 private firms

from 32 countries over the period 2007–2014. There are several pos-

sibilities for firms to reduce (prospective) employees' perceptions of

unemployment risk, which are expected to be particularly high in

countries with weak public unemployment insurance. For instance,

prior research on public firms focused on ownership structure (Ellul,

Pagano, & Schivardi, 2018) and leverage (Agrawal & Matsa, 2013).

However, private firms generally have concentrated ownership. More-

over, although private firms could also reduce their leverage to mini-

mize unemployment risk, debt is often a very crucial form of external

financing for these firms (Brav, 2009). Consistent with Devos and

Rahman (2018), we focus on firm cash holdings, which could repre-

sent a credible firm-level insurance against employees' unemployment

risk. They find that US public firms significantly decreased their cash

holdings after increases in unemployment insurance benefits in US

states between 1982 and 2010. Contrary to Devos and

Rahman (2018), we investigate cross-country differences in unemploy-

ment insurance and how this affects private firm cash holdings.

We hypothesize that privately held firms hold more cash in coun-

tries with weaker public unemployment insurance. Greater cash hold-

ings reduce the likelihood that firms must fire employees during a

period of internal or external turmoil. Accordingly, firms might hold

more cash as an insurance to diminish (prospective) employees' per-

ceptions of unemployment risk. Because this risk is particularly acute

in countries with low public unemployment insurance, precautionary

cash holdings are expected to be greater for firms in these countries.

These extra cash holdings may benefit the firm in two ways. First,

employees are willing to accept lower wages and benefits if the per-

ceived unemployment risk is lower. Second, a lower unemployment

risk facilitates the hiring of new employees (Brown & Matsa, 2016;

Devos & Rahman, 2018). In addition, we hypothesize that the

issuance of new debt, which is the main source of external finance for

privately held firms (Brav, 2009), results in larger cash balances in

countries with weaker public unemployment insurance.

A potential problem with an empirically observed relation

between public unemployment insurance and firm cash holdings is

that this relation might be driven by other factors, which are

correlated with public unemployment insurance and cash holdings.

We address this problem in several ways. First, we include in all

regression firm characteristics that have been found to significantly

affect cash holdings (e.g., Bigelli & Sánchez-Vidal, 2012; Gao

et al., 2013; Opler et al., 1999). Second, we control for country

characteristics that might be correlated with public unemployment

insurance and could affect firm cash holdings. These country charac-

teristics measure macroeconomic conditions, the availability of private

credit, legal creditor protection, and the rule of law in the country

where the firm is established. We also include two dimensions of

labor protection that have been found to significantly affect cash

holdings of publicly traded firms: the degree of unionization (Klasa

et al., 2009) and the degree of legal employment protection (Cui

DELOOF ET AL.189