One of the ongoing puzzles of this joyless recovery (to give it the benefit of the doubt) has been the huge accumulation of cash by corporations. The puzzle is that the huge cash hoards that companies are sitting on are being generated by high earnings, high earning reflected in – or, perhaps more accurately, anticipated by — rising stock prices since the stock market bottomed out in March 2009. So one would think that the high earnings would have encouraged these highly profitable companies to expand output, building new capacity and hiring new workers, rather than accumulate all that cash. But the growth in cash holdings by companies has dwarfed the growth in new capital spending and employment. So what gives?
Corporations, obviously, are not all the same, so that any simple broad generalizations about what they are doing and why are very questionable. A disproportionate share of the newly accumulated cash is in the hands of large companies, especially in the telecommunications sector, the most notorious case being Apple, whose hoard is reportedly close to 200 billion dollars. Let me also observe that the increase in cash holding by corporations has been increasing for a long time, especially since the mid-1990s, tapering off in the mid-2000s before dipping during the financial crisis. But the upward trend resumed and accelerated after the crisis.
Here are some of the reasons that I have seen mentioned or have thought of myself for all this corporate cash hoarding.
A basic proposition of the theory of the demand for money is that an increase in uncertainty increases the demand for money. It is certain that the financial crisis was associated with increased uncertainty, raising the demand for money during and, owing to residual effects of the crisis, after the crisis. One might wonder why, if the demand for money increased during the crisis, corporate cash holdings decreased. The answer is that cash flows during the crisis were drastically reduced, requiring companies to expend cash even though they would have preferred to squirrel it away. The crisis was a period of extreme disequilibrium, and corporations (like many other economic agents) were forced way off their demand curves. So some part of the increase in corporate cash holdings can probably be attributed to a general increase in overall macroeconomic uncertainty. However, macroeconomic conditions has been fairly stable now for the last two or three years, at least in the US. So, although one could argue that the general macroeconomic environment is more uncertain than it was before the crisis, it would be hard to argue that uncertainty has not been gradually diminishing over the past few years, even as corporate cash hoards have continued to grow rapidly.
Some people – I don’t have to name them, you know who they are – like to say that the increase in uncertainty is all, or perhaps only mostly, due to the policies of the Obama administration and the Federal Reserve, especially, but not only, Obamacare and quantitative easing. But Obamacare was enacted in 2010, and it has been implemented gradually since then, coming more or less fully into effect this year. So the uncertainty associated with Obamacare should have been decreasing over time. Quantitative easing has been in effect in one form or another for most of the past four years, so people have gotten used to it. There is now uncertainty about when and how it will come to an end, but there is no sign that concerns about its gradual termination are causing any major market disturbances. So one can’t easily attribute the continuing increase in corporate cash-holding to uncertainty caused by Obamacare or quantitative-easing.
There are also microeconomic sources of uncertainty that are specific to particular sectors or industries, accounting for faster rates of increase in cash-holding by particular types of corporations, but the increase in cash-holding has not been confined to any single group of corporations, though large multi-national corporations, especially technology, media, and telecommunications companies have shown the largest increases in cash holdings. A study by economists at the St. Louis Fed suggested that R&D intensive corporations, being subject to high uncertainty owing to the unpredictable outcomes of their R&D activities, have been increasing their cash holdings more rapidly than less R&D intensive corporations. As R&D expenditures increase as a share of total investment, total cash holding by corporations would be expected to increase. But, again, this explanation can account for a long-term trend towards increased corporate cash holding, but not for the surge in corporate cash holding since 2009.
Let’s think again about why a profitable company is holding a lot of cash. So what can a profitable company do with all that cash gushing into its coffers? Well, 1) it can just hold on to the cash, 2) it could invest in new plant and equipment, (we’ll come back to this in a moment), 3) it could go out and buy other companies, 4) it could pay bonuses to some or all of the employees (guess which ones) of the company, or 5) it could return the cash to the owners of the company by paying dividends or by repurchasing stock.
As promised, let’s now think a bit more about option 2). There are broadly speaking three categories of capital investment. First, there is capital investment that replaces old and depreciating equipment with new and possibly improved equipment, but does not alter the firm’s structure or methods of production. It simply allows the company to keep doing what it has been doing, but perhaps a little bit more efficiently. Second, there is capital investment that aims to alter the structure of production, by adopting a new method or technique of production. Third, there is capital investment intended to increase the total productive capacity of the firm, enabling the firm to expand its output and increase its sales.
Notice that the first category is necessary for any firm unless it is about to go out of business. A firm may postpone such investment if it is not currently profitable, but it can’t postpone it for long without compromising the viability of the firm. Capital replacement is important, but to a large extent it is automatic, not being sensitive to relatively small changes in economic incentives.
The second category does depend importantly on the relative profitability of different techniques, and these decisions require pretty careful and detailed assessments by corporate management to decide which ones will be profitable and should be undertaken and which ones are unlikely to be profitable or involve too much risk to be undertaken. I note parenthetically that it is only a subset (probably a small subset) of this category that is sensitive to the interest-rate mechanism that looms so large in Austrian business-cycle theory. To presume that this probably small sub-category of interest-sensitive investment is what drives the business cycle involves a huge, and empirically unsupported, assumption.
The third – and undoubtedly the largest — category depends primarily not on calculations about the relative cost and profitability of different techniques, but on expectations about future demand for the firm’s output. If firms believe that they can increase sales at current prices, they will expand capacity to produce more output. If they don’t invest in increased capacity, they will probably lose market share to their competitors.
So, if corporations have been accumulating cash rather than investing in new plant and equipment to expand output – the sort of investment that would involve major expenditures and a significant drawdown of cash hoards — the most obvious explanation seems to be that firms don’t expect future demand at current prices to increase enough to justify such investments. A surge in corporate cash holding is an indication that corporate expectations about future demand are not very optimistic. Mildly pessimistic expectations about future demand are not inconsistent with high current profitability and rising stock prices.
I will not comment about why companies are not using their cash to buy other companies or to pay more and bigger bonuses to employees, but I do want to say something about why companies aren’t paying higher dividends to stockholders or buying back stock. One reason that they are not increasing dividend payments is that dividends are not tax-deductible. The non-deductibility of dividends is a terrible flaw in our corporate tax code. (See this post about Hyman Minsky’s opinion of the corporate income tax.) It penalizes giving the owners of companies the ability to decide how to allocate their capital, locking up capital in existing corporations because capital gains are taxed at a lower rate than dividends.
Now it would still be possible for corporations with excess cash to repurchase stock, allowing stockholders to be taxed at the lower rate on capital gains instead of the higher rate on dividends. But for multinational corporations, there is another obstacle to returning cash to stockholders either by paying dividends or by stock repurchase: cash now held overseas would be subject to the 35% corporate tax rate on either dividends or stock repurchases, imposing a huge penalty on returning idle cash to stockholders. So, instead of the cash being made available to millions of stockholders to spend or invest as they wish, creating new demand for output or providing capital to firms seeking new financing, the money is now effectively embargoed in corporate treasuries. What a waste.
Uneasy Money 
“So, if corporations have been accumulating cash rather than investing in new plant and equipment to expand output – the sort of investment that would involve major expenditures and a significant drawdown of cash hoards — the most obvious explanation seems to be that firms don’t expect future demand at current prices to increase enough to justify such investments. A surge in corporate cash holding is an indication that corporate expectations about future demand are not very optimistic. Mildly pessimistic expectations about future demand are not inconsistent with high current profitability and rising stock prices.”
David, this is a great point. Two further bits of evidence to support your argument are below including one empirical and one theoretical.
Empirical evidence is from this paper http://www.usc.edu/schools/business/FBE/seminars/papers/ARF_3-29-13_KOTHARI-KLW_Invest.pdf
shows that investment increases as interest rates rise, implying that QE is unlikely to ever have much impact in stimulating new investment. But it is a reasonably good mechanism at stabilising a disrupted system allowing firms to refinance at lower rates and increase profits during periods of lower aggregate demand.
The theoretical piece of evidence is of course Keynes’ comment in the GT where he argued that a large increase in the quantity of money may cause so much uncertainty about the future it may strengthen liquidity preferences.
It therefore could be argued that central banks have been partially responsible for this lack of investment as they have been communicating to firms that all is not well with the economy. An interesting counter factual analysis would be to see whether investment would have increased had central banks after a period of stabilisation, communicated that everything was now all right with the economy.
It seems plausible that investment and aggregate demand might well have increased, although the net result of this communication may well have been slightly higher interest rates. According to a standard ISLM analysis this would reduce investment not stimulate it. However the cited paper above along with some of my own thoughts here
http://www.creditcapitaladvisory.com/2014/09/04/swedish-perspective-equilibrium-level-interest/
suggest that as investment is rarely made at the margin, the standard ISLM model does not appear to reflect reality in numerous instances.
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I always enjoy reading your posts.
I suspect that one issue is the profile of savers. Developing world savers and developed world baby boomers present an unusually large pool of savings that is risk averse. While the total required return on corporate assets seems to remain fairly level, risk aversion will push down risk free rates and push up the risk premium for owning equities.
I have shown that, contrary to some intuition, low interest rates are associated with low corporate leverage. This could be partly due to tax issues and partly because the higher level of risk aversion among savers might push the equilibrium leverage of corporations to a safer level.
Here is a post introducing this idea:
http://idiosyncraticwhisk.blogspot.com/2014/06/risk-valuations-part-3-low-interest.html
Here I look at returns to capital, including debt and proprietor income, to show that returns to capital aren’t unusual. High profits are simply an accounting artifact stemming from the trend toward higher equity funding levels. Fewer returns are going to debt – partly because of low rates, but mostly because of low levels of debt in the capital mix.
http://idiosyncraticwhisk.blogspot.com/2014/10/returns-to-capital-arent-high.html
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Very good. http://www.miguelnavascues.com/2014/10/el-misterio-de-la-liquidez-atesorada.html. See graph
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I have no idea what the right answer might be.
But:
a) The “liquidity trap” induced by tax disincentives that discourage repatriation of foreign domiciled cash (as you have pointed out)
b) A precautionary motive that is proportional to the generally tighter availability of credit even coming out of the financial crisis. This may also include a precautionary stock-piling of liquidity resulting from advance debt funding of corporate balance sheets due to low interest rate opportunities – where they have been taken advantage of.
c) A de facto balance sheet matching of the “liquidity trap” that exists on the other side of bank balance sheets in the form of stagnant excess reserves. Bank balance sheets must balance, although this can happen in different ways. Still, there is a sort of supply side effect on the liability side in the sense that banks don’t necessarily want to transform demand deposits into anything fancier or higher yielding when they have all those low interest short term interest rate sensitive reserves on the asset side. There is an asset-liability matching problem to be considered in the face of $ 3 or 4 trillion of useless stuff on the asset side.
d) A disproportionate weighting of general corporate liquidity resources toward cash rather than close by non-cash alternatives, due to the flat yield curve and the “liquidity trap” effect of that.
I’ve probably abused the usual meaning of the term liquidity trap here – but maybe it deserves to be abused.
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If return on cash (via deflation “expected”) are greater than returns elsewhere (‘expected. Holding cash would be sensible strategy.
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Why invest in something when your customers have no money?
It’s the hollow middle class.
The people who buy products are broke. The people who buy assets are rich. Therefore, rising asset prices and low demand for new, more, better goods and services.
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Great blogging.
Couple notes: Corporate holding of cash is at record highs, but then so are corporate profits. They are making more money than ever before, both relatively and absolutely.
I agree dividends should not be taxed, as part of a larger overall scheme that productive behavior should never be taxed.
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Inadequate aggregate demand…..of course
Since income derived from profit seeking ventures always has to have a greater amount coming in from sales than is laid out in income….then if the economy as a whole is profit seeking ventures….then the economy is not viable……
Because income has be derived both from sales (consumption) ..and investment of preexisting wealth
Without investment of preexisting wealth the macro economy is not viable
Those who are running for profit ventures will not invest unless sales is greater than investment plus income
So government must intervene
Government can do this with direct taxation and investment
and by a tax code that encourages investment
In a stable and just society we would all have savings and spending that savings would contribute to and count as investment
Enough investment will increase the marginal efficiency of capital and those corporations would start to invest that cash
Total wealth for us all increases because some of the goods produced with increased investment are of a durable nature and because of the advances produce in technique and technology that goes along with increased investment
Hoarding and miserliness prevent that from happening
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The managements are not paying workers living wages. This adds to the cash heap. High unemployment and anti-union rules put too little pressure on management. This behavior, in aggregate, creates slack demand in the economy as workers cannot afford to buy the products they make.
Business has future expectations based on the past. Expectations for a surge in demand after recession would require cash to meet the higher demand. That higher demand has not materialized and the MBAs that run these companies are using the old models that say economic demand recovers. Demand is not recovering because our political elites are not implementing policies to increase demand. In fact, they are doing the opposite. A change in policy could change the business climate to create a surge in demand. Business are planning for that. They are not planning for a declining wage/ declining demand spiral accompanied by de-flation or no-flation that makes borrowing for investments more unappealing, but that is the economy the policies of our elite overlords are producing.
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I think our tax code is corrupt and that is causing the imbalances. All income should be taxed at the same progressive rates. We have developed probably the worst form of capitalism; capitalism without a social conscience. An indifferent government looks the other way while corporations dodge tax responsibilities openly, and legally. Initial income distribution is unfair, with the capital owners and their corporations hoovering up every nickel. They are suppressing wages so that labor is not being paid proportionate to its contribution. Demand thus suffers, as Keynes pointed out more than 80 years ago.
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If you need your overseas cash back in the USA you borrow it from the sub at an attractive transfer pricing. Bingo.
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“Let me also observe that the increase in cash holding by corporations has been increasing for a long time, especially since the mid-1990s, tapering off in the mid-2000s before dipping during the financial crisis.”
Finn Poschman points out that the rise in cash holdings has been twinned with a fall in short term assets like inventories and accounts receivable. So the long term trend to hold more cash is just one half of a secular asset switch out of one short-term liquid asset into another.
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link:
Click to access e-brief_143.pdf
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Interesting post but …
1) Companies are buying back stock at high, if not record, levels. (http://online.wsj.com/articles/companies-stock-buybacks-help-buoy-the-market-1410823441)
2) A bigger issue than mere taxation of dividends is the difference between tax rates on dividends and those on capital gains. Favoring one over the other is a recipe for getting more of the cheaper.
3) You note ” A disproportionate share of the newly accumulated cash is in the hands of large companies.” For such companies US economic prospects are only part of the story. World GDP growth has been anemic since partially recovering from the recession over 2009-10 period. Maybe companies are hoarding cash because of diminished world economic prospects?
http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?display=graph
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Looking at aggregate numbers, profitability has been reasonable at the largest corporations level, but not at the level of not so large corporations (just check the current P/E for the S&P 500 and for the Russel 2000). Maybe corporations don’t feel the need to reinvente their own business, maybe there are not a lot of growth opportunities for them out there. When there is not a lot of opportunities out there, cash piles up …
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Is this author crazy? There have been a slew of multi-billion-dollar mergers and acquisitions. And these companies have been paying huge bonuses to their executive employees (also in the form of stock options). And stock buy-backs are also at historic levels. They DO use excess cash to repurchase stock to pay the lower capital gains tax rate on realized capital gains from executive stock-option grants. And regarding repatriated earnings: there’s a huge difference between a “statutory” tax rate and an “effective” tax rate. Many of these multinationals had an effective tax rate of ZERO! And the money saved on untaxed dividends would probably not be reinvested — for lack of consumer demand — and why corporations have no need to reinvest. And so this extra cash might also be hoarded! This entire post was nothing more than an argument to lower taxes for the very corporations who have been paying record low taxes as a percentage of GDP since the 1950s — all while raking in record profits (DOW closing at another record high today.) And income and wealth inequality has been increasing since 1979. If anything, they should be paying Social Security taxes on all their capital gains — and/or be taxed to provide a Basic Income for all the people they’re putting out of work with offshoring and robotics.
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JP
Interesting paper.
I can see the argument in terms of observing what appears to be substitution.
But I don’t see a very cogent argument on the need for substitution. Which begs the question about whether it actually is substitution. Which if not takes us back to square one.
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The joyless recovery is reminiscent of a sentiment from a book by Tibor Scitovsky:
The Joyless Economy: An inquiry into human satisfaction and consumer dissatisfaction, 1976
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Ya know, you could just go and ask them
Gathering data through experiments is called science
long blog posts on theory is called economics
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The economy is dead in the water. Incomes have been stagnant for 30 years. There is nothing to invest in, because no one has any money to buy things.
The tax on dividends argument is silly. Companies that don’t pay dividends don’t pay them because the CEO wants the feel of the money under his control. As a shareholder, I’m more than glad to pay taxes on dividends, if only more companies would pay them.
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Technology is disruptive. And this makes the sector less certain. That would be consistent with uncertainty if you expect the most uncertain sector to hold the most cash. You would have to look at whether the tech sector had a change in cash holding as a ratio of size. And or whether the tech
sector was a larger share of corporations.
I thought type three cape was also interest rate sensitive because supply cost is lowered so demand left unfilled as costs were too high is filled at that price by building new supply
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like this
Mortgage Origination Fraud and the Global Economic Crisis: A Criminological Analysis
the authors interveiwed 23 people employed in the banking sector..
It ain’t that hard; you get one or two grad students, or even sharp undergrads, you devise a structured inteview, and you go out and talk to people
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Apologies to all for the tardiness of these responses. Life intervened.
Thomas, Looks like an Interesting paper, but I am skeptical of an empirical result suggesting that overall investment is not negatively correlated with interest rates. But I certainly agree that interest rates are not the most important determinant of investment. I am also skeptical of how powerful central bank signals about the state of the overall economy are. But clearly there is now a lot of ambiguity about what signal a low central bank rate is sending. Does it signal that the bank expects the economy to b e weak or that the bank is aggressively trying to ease policy?
I also agree that a lot of investment decisions are not made at the margin, but does anyone suggest that most investment decisions are sensitive to a small change in the interest rate? Isn’t the argument, that there will usually be some investment decisions that will be affected?
Kevin, Thanks. Well, if low interest rates are associated with rising stock prices, and firms are not investing a lot in new capacity, that would suggest that debt would be declining as a percentage of total capital. That said, it is not necessarily clear what the direction of causality it.
Luis, Thanks.
JKH, It’s not clear to me that banks are able to offer most businesses financing at sufficiently low cost to make it worthwhile to obtain bank financing. Banks earn profits from the spread between lending and borrowing rates, and the spread is too narrow, for banks to make a lot of loans. They’re making it up on the fees that they are charging.
Jack, I agree.
Thornton, You are describing what might be called a low level equilibrium. There might also be a higher-level equilibrium in which there would be more spending and more employment all the way around.
Benjamin, Thanks. The problem is that a lot of corporate behavior is not as productive as it seems, especially in the financial sector, but also in other sectors, e.g., pharmaceuticals and other areas where the profits earned are not necessarily reflective of net benefits to society.
djb, Jonny and Chris, I am aksing a narrower question than you seem to be discussing. Given the profits that businesses are earning now, why are they retaining so much of it as cash rather than giving it back to the stockholders.
john, Transfer pricing determines the allocation of profits between different corporate entities within a a multinational firm. I don’t see how transfer pricing is related to internal borrowing and lending. But I don’t know much about multinational corporate finance.
JP, But why should corporations be switching out of holding inventories into holding cash rather than giving the capital savings back to stockholders? The motives for holding inventories don’t seem to be the same as the motives for holding cash.
Bobby, Corporate buybacks of stock may be at record levels, but why aren’t they even higher if the alternative is that corporate cash holding is also at record levels?
Jose, Again, the question is why is the cash piling up inside corporations rather than being returned to stockholders.
Bud, You said:
“Is this author crazy?”
Well, you never know. Anything is possible.
“There have been a slew of multi-billion-dollar mergers and acquisitions. And these companies have been paying huge bonuses to their executive employees (also in the form of stock options). And stock buy-backs are also at historic levels. They DO use excess cash to repurchase stock to pay the lower capital gains tax rate on realized capital gains from executive stock-option grants. And regarding repatriated earnings: there’s a huge difference between a “statutory” tax rate and an “effective” tax rate. Many of these multinationals had an effective tax rate of ZERO! And the money saved on untaxed dividends would probably not be reinvested — for lack of consumer demand — and why corporations have no need to reinvest. And so this extra cash might also be hoarded!”
But the slew or mergers and the bonuses and stock buybacks haven’t been enough to keep corporate cash holdings to increase since 2009 at the most rapid rates ever.
Medici1, Yes, the phrase came to me as I was writing and I realized that I was borrowing it from the title of Scitovsky’s book, which, I admit, I never read.
Ezra, You know, so could you.
kaleberg, Well, some companies pay dividends and you can invest in the ones that do, but people who invest in those companies bear a higher tax burden than those invest in companies that don’t pay dividends.
Dan, Type three may be interest rate sensitive to some degree, but it seems far more sensitive to expected future demand.
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“djb, Jonny and Chris, I am asking a narrower question than you seem to be discussing. Given the profits that businesses are earning now, why are they retaining so much of it as cash rather than giving it back to the stockholders”
so it is not so much about why hoard cash as it is where to hoard it
assuming , ultimately the value of the company is held by the stockholders
either way it is not investment
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djb, I call it corporate hoarding if the cash is kept on the books of the corporation. If the corporation transfers the cash to owners by stock buy backs or by paying dividends, it is up to individuals to decide whether to keep holding the cash or to spend it. They may or may not continue to hoard, but the decision would be made by each individual stockholder not by corporation.
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Yes, well at one point higher tax rates would encourage capital investment tather than hoarding or paying dividends
Ultimately of course one have worry about having customers (aggregate demand) so all that investment did not go to waste
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