Corporate Cash: Is Holding Too Much a Problem?

Corporate firms are holding record amounts of cash on their balance sheets. Apple, for example, has $178bn in reserves. That’s enough to pay every American $556, or buy a Big Mac for everyone in China for 47 consecutive days. A recent study carried out by Deloitte in 2014 revealed that 963 non-financial firms were holding $2.6trn in cash. Separate research carried out by St Louis Fed found that, after adjusting for economic growth and inflation, cash on corporate balance sheets had doubled between 2000 and 2010. Is this a problem? What can this tell us about the current economic climate?

Firstly, the evidence: in order to take into account the increase in inflation and the total number of firms, we use a ratio of cash to net assets. The evidence in the graph below shows that the ratio has doubled since 1990. This essentially shows that companies are holding more cash on their balance sheets as a proportion of their assets than ever before.

Ratio of Cash to Net Assets

SOURCE: Compustat.

NOTE: Sample includes all U.S. firms in the data set except financial and utility companies. Cash-to-net assets ratio is found by dividing aggregate cash and equivalent assets by aggregate total assets minus cash and equivalent assets.

According to economic theory, each firm should hold an appropriate level of cash to cover interest, expenses, capital expenditure, and simply as a precaution or in case of emergency; any spare cash should be returned to the shareholders through dividends or buybacks.

However, there needs to be an explanation for this increase in cash on companies’ balance sheets. The first is in keeping with the theory: Firms may be holding precautionary reserves because of economic or fiscal uncertainty. Examples of this include the US government shutdown, the Scottish vote on independence, and the upcoming UK election. These political events lead companies to postpone investment until the uncertainties about fiscal policies are resolved, thereby building up cash reserves.

The second explanation is tax. US corporations have built up a cash pile of up to $2trn overseas which would be taxed at 35% if it were repatriated back to America. In short, they are hoarding it from the US government.

So, is this a problem?

For governments, the cash piles represent lost taxes. Companies are not only holding cash overseas that would otherwise be taxed if it were repatriated, but they are also withholding investment, which means potential jobs, and therefore tax receipts, are not being created.

Lower investment in human and physical capital also means slower productivity gains, which hampers the economic recovery. If companies put these cash reserves to use by investing in increasing their capacity, such as a dockyard buying more machinery, then this could spur on economic growth. Instead, the cash is simply being held in the bank.

Furthermore, there is an opportunity cost that is incurred by holding this money as cash. In an era of record low interest rates, the return on holding cash has decreased as the interest on bank deposits and yields on government bonds have also fallen. This means that as the return on cash has fallen, the opportunity cost has risen.

But what should these companies do with their money?

The last five years have seen the rise of activist investors who call upon companies to return cash to shareholders. In 2013, hedge fund manager David Einhorn went as far as filing a lawsuit against Apple after the company decreased the amount of cash it would return to shareholders. This has been happening on a wider scale too and is perhaps why almost $914bn was returned to investors in the form of dividends and share buybacks in 2014.

However, there are two problems with this. Firstly, because multinational corporations have cash reserves overseas, they are funding these buybacks through debt not cash so as to avoid tax. Secondly, and most importantly, it shows that the current world economy does not offer good enough investment opportunities. This implies that the overseas cash reserves will simply continue to sit in the bank. Maybe they should start handing out free Big Macs in China after all.

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