Saturday, August 17, 2013

Insight Into The Rise In Company Cash Levels

In a research report earlier this year, the Federal Reserve Bank of St. Louis provides some insight into why companies continue to hold higher levels of cash. The increasing cash level trend has been underway for over thirty years so the higher cash trend likely is not simply due to economic uncertainty. The research report looks at both absolute cash levels as well as cash as a percentage of corporate assets. This cash level issue is important for investors as cash is essentially an asset that generates little if no return in the short run for a company and hence its investors: especially in light of the current low interest rate environment.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Several factors are cited in the report that provides insight into a company's desire to hold higher cash. One factor cited is the change in the composition of companies, i. e., today companies are more focused on research and development (R&D). This transition has occurred through the growth in the information technology and the pharmaceutical/medical device industries. These industries rely heavily on R&D in order to develop new products.

The other factor driving corporations to desire holding more cash is a policy one. This policy issues relates to the differing tax regimes pursued by countries around the world. For U.S. companies, the additional taxes owed on repatriated earnings leads company managements to leave cash in lower taxed countries. The research report provides detail around this issue.

As noted below in a portion of the report's conclusion, the undesirable impact of tax policies could be constraining the growth potential of the U.S. economy.
There is a structural factor, the increasing importance of multinational corporations, that seems to be important because of the current taxation of the income generated abroad that domestic corporations bring back to the U.S. Here, fiscal policy may be playing an undesirable role, and its modification in the coming years could boost domestic investment and help overcome the slow recovery from the Great Recession.

There is also another role for fiscal policymakers in the near future. Although the magnitude of the effect is not clear, it seems that designing and communicating a long-run plan to deal with the increasing fiscal deficit would reduce uncertainty about future taxes, reduce abnormal cash holdings and potentially favor private investment.


Why Are Corporations Holding So Much Cash?
Federal Reserve Bank of St. Louis
By: Juan M. Sánchez and Emircan Yurdagul
January 2013

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