Tom Bates: Why Cash is King
Interview with ASU Professor and Finance Department Chair Tom Bates. At a recent meeting of the Economic Club of Phoenix, WP Carey School…
Jeff: Why are companies holding such large amounts of cash these days?
Bates: The trend has been ongoing. But demand for cash holdings has spiked due to a number of connected and independent reasons. The beginning of the trend might be marked to the fallout of Lehman Brothers, the 150 year old investment and trading firm whose bankruptcy had a ripple effect in financial markets around the globe.
Why did the Lehman bankruptcy cause this avalanche of financial uncertainty?
Lehman’s default created this degree of uncertainty partially because it happened before the subsequent government intervention, and markets froze as a consequence of not understanding the impact on falling asset values. Let’s remember, most balance sheets were already being marked down and fair value accounting played a role in the subsequent decline in liquidity and equity. Even after intervention, credit was unavailable to the most creditworthy companies. The response was to hoard cash, naturally. I would liken it to ‘depression era’ adults who stored cash in their homes due to fear of bank failures. Not surprisingly, over the next few years – and they have been good years in terms of growth but they were difficult years as well – companies have adopted a philosophy that could best be described as cash is king. And in times when business is growing, that emphasis has resulted in mountains of cash on the balance sheets. Each company hopes to have it’s own Fort Knox.
How much cash are we talking about?
Roughly $4 trillion or twice the amount of corporate liquidity immediately pre-crash. So, a substantial uptick in cash balances. Firms have used the recovery to reliquefy themselves to the point where we are today, swimming in the stuff.
Which firms have the most and where is it held?
You will not be surprised to learn that apple with $160 billion and Microsoft with $84 billion are the largest cash holders in the corporate world. Google has $59 billion. Compare that to the original cash is king guru, Warren Buffett, whose cash pile is a mere $40 billion. Apple has roughly two thirds of their cash or $100 billion kept abroad. Apple’s cash balance is about equal to all the countries of the Euro Zone.
What are the downsides to holding all this cash?
Unwelcome attention from academics like me, pundits, analysts, and shareholder activists who believe it’s the shareholder’s cash and should be returned. As regards the question of overseas cash and whether that is the most efficient use companies have adopted what I call a ‘synthetic repatriation’ in the form of short term debt. The way that works is a country has a 1 billion in overseas banks and would have to pay upwards of 15 – 18% to repatriate it under current U.S. tax policy. So the company simply borrows against that cash at 4% and uses the debt as if there cash was here in the U.S., with no gap in investment or shareholder payouts. Therefore the idea that somehow companies are ‘hurting’ their shareholders or underinvesting is simply not true.
What about global corporate tax rates?
Under the Clinton administration, corporate tax rates were raised to 35%. Only at that time, it was close to the average of the OECD countries. Today, the OECD is hovering in the low 20’s and some countries are at 20 or lower such as the UK and Ireland. With state and federal taxes combined, U.S. corporate tax rates are at 40% according to KPMG’s recent study. For a company to bring back the cash they originally made from a sale of goods in a foreign country, say Ireland where they paid 10% tax, would require paying the differential or nearly a 30% haircut for what amounts to a wire transfer.
What kind of overseas holding are we talking about here?
Bloomberg thinks upwards of $2 trilliion is being held overseas.
Will Washington lower taxes or institute a tax holiday?
It would make sense.
Any other reasons that come to mind as to why cash is being held?
The revolution in the boardroom I call it. Boards today are very different from their brethren in the 80’s. In fact, analysts measure the value of cash based on how efficiently it’s used. In the 80’s, for instance, each $100 of cash a value was given as low as $60 because cash was spent unwisely. I call it the shag carpet indicator. Companies would buy a flashy new plane or spiff up their headquarters, and the cash simply didn’t create value equal to its nominal amount. Today, those analysts value cash at $100 to $150, suggesting cash is being spent so efficiently that it gets a multiplier. As for other reasons, we should not forget all the risk a company encounters including global risk, credit risk, regulatory risk. In periods when risk is rising, cash can help guarantee stability.
Do you think the stimulus has any room to go.
I would have said none because I didn’t believe the stimulus could go below zero in terms of monetary rates. But recently a German bank charged for cash holdings, implying that cash balances receive a negative return. So there is that bit of room to go if we need it.