Why do U.S. firms hold so much more cash than they used to? by Bates, Kahle, and Stulz.
Short version: firms are holding more cash now than they used to. This runs counter to theory that would suggest that as transaction costs decrease and hedging opportunities increase, cash holdings would decrease. Interestingly the increased cash holding does not appear related to agency cost explanations.
Longer Version: Bates, Kahle, and Stulz look at the surprising fact that firms hold more cash than they did 20 years ago. In what is even more surprising, this increased cash holding does not appear to be caused by agency costs.
In the words of the authors:
"[We] investigate how the cash holdings of
firms have evolved since 1980 and whether this evolution can be explained by changes in known determinants of cash holdings. We find that there is a secular increase in the cash holdings of the typical firm from 1980-2006....the average cash-to-assets ratio (the cash ratio) has increased by 0.46% per year. Another way to see this evolution is that the average cash ratio more than doubles over our sample period, from 10.5% in 1980 to 23.2% in 2006....In the absence of agency problems, improvements in information and financial technology since the early 1980s should have led to a reduction in corporate cash holdings." U.S.
"...Foley, Hartzell, Titman, and Twite (2007) show that one reason for the cash buildup is that
firms had profits trapped abroad that would have been taxed had they been repatriated. In our sample, we find that firms with no foreign income also experience a secular increase in the cash ratio." U.S.
In what may be seen as the surprise of the paper, the authors look at several proxies for agency costs but do not find there to be a relationship. In the least surprising finding, they report that the increase is most concentrated in firms that do not pay dividends.
So why the increase? It seems that much of it is attributed to increases in business risk. Again from the paper:
"It is well-known that idiosyncratic risk increased over much of our sample period (see
, Lettau, Malkiel, Xu, 2001). When we divide the industries in our sample into quintiles according to the increase in idiosyncratic cash flow volatility, we find that the average cash ratio increases by less than 50% for firms in the industries that experience the smallest increase in risk but by almost 300% for firms in the industries that experience the greatest increase in risk" Campbell
Another REALLY important finding of the paper is that common measures of leverage may not be good indicators of debt levels once cash is accounted for:
"...the net debt ratio (defined as debt minus cash, divided by book assets), a
common measure of leverage for practitioners, exhibits a sharp secular decrease; most of this decrease in net debt is explained by the increase in cash holdings. The fall in net debt is so dramatic that average net debt for
firms is negative in each of the last three years of the sample (2004, 2005, and 2006). Consequently, using net debt leads to dramatically different conclusions about both the current level of leverage in U.S. firms and the evolution of leverage over the last twenty-five years." U.S.
Good stuff! Will DEFINITELY be used in class! Read it in its entirety here.
Bates, Thomas W., Kahle, Kathleen M. and Stulz, René M., "Why Do