The Impact of Firm’s Excess Cash Holdings on the Relationship between Information Asymmetry and Earnings Management

Recent studies provide ample evidence that the average cash holdings of U.S. firms dramatically increased over recent years. The purpose of this study is to empirically investigate whether the significantly positive relation between the degree of information asymmetry and the magnitude of earnings management, which is predicted and proved by prior theoretical and empirical studies, can be differentiated by the level of firm’s excess cash holdings. Using the sample of firms listed on U.S. stock markets from 2004 to 2012, we find that the positive relationship between information asymmetry and earnings management becomes less significant when a firm has higher level of excess cash holdings. Moreover, our additional analysis reveals that this impact of excess cash holdings is more profound in the post－financial recession period than the pre－financial recession period.