Do Corporations Retain Too Much Cash? Evidence from a Natural Experiment.

The article examines the impact of a 2014 South Korean tax reform that imposed a 10% surtax on excessive corporate cash retention, targeting firms with book equity above 50 billion Korean won or those belonging to large business groups called chaebols. Using difference-in-differences and event study methodologies, the study finds that treated firms significantly reduced cash retention—by nearly half—and reallocated funds toward increased payouts, investments, and wage increases. Market reactions to the reform were positive, indicating that firms had been retaining excessive cash, and the marginal value of cash for treated firms rose closer to one dollar. The analysis further identifies behavioral biases, such as firms' memories of the 1997 Asian financial crisis, and agency conflicts related to corporate governance as key mechanisms influencing cash retention and the efficiency of alternative cash uses. Well-governed firms tended to increase payouts and experienced positive valuation effects, whereas poorly governed firms increased investments without corresponding valuation gains, suggesting potential empire-building. The findings highlight that policies discouraging cash hoarding can improve firm value but their effectiveness depends on firms' underlying motivations and how freed-up cash is deployed.