More than anything else, it comes down to taxes
A common explanation for the increase in cash-holding has been the increasing importance of rainy-day funds. Image: Shutterstock
In recent years, the rise in cash held by US companies has been dramatic, skyrocketing from $1.6 trillion in 2000 to about $5.8 trillion today. This trend has concerned investors, who would prefer to see the money either put to productive use or returned to them in the form of dividends.
A common explanation for the increase in cash-holding has been the increasing importance of rainy-day funds, particularly for firms whose valuations are subjective, and who might struggle to access capital quickly when the need—or opportunity—arises. But there is also another possibility: a desire to minimize taxes.
So in a new study, researchers set out to determine how much of the trend toward cash-hoarding could be explained by these two competing theories. Their analysis reveals that, for the bulk of the increase, it all comes down to taxes.
Mitchell Petersen, a professor of finance at Kellogg, and his coauthors found that foreign cash-holdings were increasing more quickly than domestic ones—particularly in nations with the lowest tax rates. They also determined that a particular sector of U.S. corporations is driving the cash-hoarding: multinationals whose value is generated primarily by their intellectual property, which tends to be far easier than physical goods to move around the globe for tax-related reasons. These companies, whose likes include Alphabet, Apple, and Microsoft, produced 92 percent of the rise in cash that the research team was able to document.
Many economists have long suspected that tax avoidance plays some role in cash-hoarding, Petersen explains. But the extent to which the increase in this behavior can be explained by tax strategy was unexpected.
[This article has been republished, with permission, from Kellogg Insight, the faculty research & ideas magazine of Kellogg School of Management at Northwestern University]