A Funny Thing Happened On The Way To Bank

¹²A Funny Thing Happened On The Way To Bank
Huge Corporate Cash Holdings Not What They Seem

By Mark Hulbert, Marketwatch | 9 October 2010

CHAPEL HILL, NC (MarketWatch)— It makes for a compelling story line: Stingy corporations, having returned to profitability after the Great Recession of 2008, are choosing to build up huge piles of cash rather than return much of it to its rightful owners, the shareholders. There's just one problem with this story, however: It's not true— at least not for corporate America as a whole.

Consider the data, courtesy of Ned Davis Research. (It was from this firm that I learned about the other side to this story about corporate cash.) Since the end of 2008, while cash at non-financial U.S. corporations has risen by $417.4 billion, liabilities have risen by almost the same amount— $405.2 billion.

Unfortunately, most of the financial media, when focusing on the big jump in corporate cash, ignores this simultaneous increase in liabilities. This strikes Ned Davis as "a little dishonest": We shouldn't "talk about [only] one side of the balance sheet and not mention the other". But talking one-sidedly is what the investment arena continues to do, leading to intensifying calls from investors for companies to share their wealth— through dividend increases and share repurchase programs.

(Read Oct. 4 story.)

To gain more insight into what's going on, I contacted two finance professors whose research focus is corporate finance generally, and in particular the trade-off between financing growth through internally-generated cash and by turning to the external debt markets: Heitor Almeida and Murillo Campello, both of the University of Illinois at Urbana-Champaign. They suspect that several different factors could be at work here. One is that memories are still fresh of the credit crunch in late 2008 and early 2009, during which the debt markets suddenly and completely closed for much of corporate America— leading some otherwise profitable companies to the brink of bankruptcy. If another crunch were to occur, sheer survival would require such corporations to have much bigger amounts of cash on hand— even if it means having to go further into debt to get it.

On this theory, today's low interest rates are a contributing factor to the big buildup in corporate cash levels. Just consider the announcement this week that Mexico will be selling $80 billion in 100-year bonds. (Read Oct. 5 story.) If Mexico— which has had several close encounters with bankruptcy in recent decades— can sell bonds that won't get repaid until all of us are long dead, then few publicly-traded U.S. companies should find much difficulty in issuing debt either.

Another possible motivation for the big corporate cash buildup, according to the professors, is that "firms are preparing for an expansion and may fear that the cost of external finance will rise in the future." It would be relatively encouraging if this were indeed their motivation, since it would mean that companies have profitable future uses to which they can put their cash to work and are shrewd enough to finance that future investment at today's rock-bottom interest rates. Far more worrisome would be yet a third possible motivation that the professors raised: "Firms are issuing debt simply because they 'can' and parking it in a cash account with no very good use for it."

This would be discouraging, the professors argue, because it "allows for massive amounts of waste and also conflicts inside the firm." No doubt each of these three motivations are at work in varying degrees, and probably others besides. But, in any case, I think it is clear that the situation is far more complex and nuanced than is implied by those who would focus exclusively on the big buildup in cash holdings alone.

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Normxxx    
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