“Record levels of cash on corporate balance sheets.”
“The cash is just waiting for confidence to pick, and you’ll see it flood into the economy.”
“Why are corporations sitting on all this cash?”
I’ve heard variations of these comments about cash on the balance sheet for years now. Thanks to Barry Ritholtz’s fine blog, I read a paper by a couple economists at the St. Louis Fed who spent many working days to figure out the Why of this issue – Why Are Corporations Holding So Much Cash?
(They’re not the first to try and answer this question. Here is an Oct 2009 paper by other economists, and they mention work by others on the subject. As I said, the whole topic is nauseating in its frequency.)
Here is one chart they use to illustrate the issue, showing how cash as a percentage of net assets for U.S. corporations has risen substantially over the last 20 years:
After many such charts, citations, and discussion, they conclude the following:
The firm-level data and the analysis of the academic literature presented above suggest that U.S. corporations are holding record-high amounts of cash for several reasons. The trend that started in the early 1990s is largely attributed to structural factors and is likely to be independent of the financial crisis. In particular, the rising predominance of R&D and increasing competition in sectors such as information technology seem to have contributed to the rise of cash holdings of U.S. corporations. The role of these factors is likely to be present in the next several years.
There is a structural factor, the increasing importance of multinational corporations, that seems to be important because of the current taxation of the income generated abroad that domestic corporations bring back to the U.S. Here, fiscal policy may be playing an undesirable role, and its modification in the coming years could boost domestic investment and help overcome the slow recovery from the Great Recession.
There is also another role for fiscal policymakers in the near future. Although the magnitude of the effect is not clear, it seems that designing and communicating a long-run plan to deal with the increasing fiscal deficit would reduce uncertainty about future taxes, reduce abnormal cash holdings and potentially favor private investment.
Nowhere in the entire paper does it mention the effect of near-zero interest rates! I read it 3 times to make sure. What’s the cost of holding all of that cash? Shouldn’t the price of the cash matter? What a concept! You can even see that the ratio on their chart has risen most rapidly in periods after extreme Fed easing.
I propose a simple theory for why there is so much excess cash: The cost to hold that cash is at all-time lows for U.S. companies. Especially for the best companies, the cost of raising that cash is at all-time lows. When the largest U.S. corporations can issue bonds yielding 1-2%, they do it as a very cheap form of insurance (and in some cases, an easy way to juice EPS by issuing debt, then using the cash to buy back stock). In fact, if you look at the cash-to-liability ratio for U.S. corporations, it’s in the bottom half of its 50 year range, meaning cash levels are not high in proportion to the debt levels at U.S. corporations.
It amazes me that entire papers are written without discussing the price of cash, particularly since the economic theory is based on the study of incentives. Prices often determine incentives. So it would make sense to check the price of cash to as an initial starting point for the “cash on the balance sheet” discussion.
As the old joke goes:
An economist is a trained professional paid to guess wrong about the economy. An econometrician is a trained professional paid to use computers to guess wrong about the economy.