Why Are Corporations Hoarding Trillions?
Why Are Corporations Hoarding Trillions?
original article by Adam Davidson , On Money , NY Times
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There is an economic mystery I’ve been struggling to understand for quite some time, and I’m not the only one who’s confused: Among financial experts, it is often referred to as a conundrum, a paradox, a puzzle. The mystery is as follows: Collectively, American businesses currently have $1.9 trillion in cash, just sitting around. Not only is this state of affairs unparalleled in economic history, but we don’t even have much data to compare it with, because corporations have traditionally been borrowers, not savers. The notion that a corporation would hold on to so much of its profit seems economically absurd, especially now, when it is probably earning only about 2 percent interest by parking that money in United States Treasury bonds. These companies would be better off investing in anything — a product, a service, a corporate acquisition — that would make them more than 2 cents of profit on the dollar, a razor-thin margin by corporate standards. And yet they choose to keep the cash.
Take, for example, Google. Its new parent company, Alphabet, is worth roughly $500 billion. But it has around $80 billion sitting in Google’s bank accounts or other short-term investments. So if you buy a share in Alphabet, which has sold for roughly $700 lately, you are effectively buying ownership of more than $100 in cash. With $80 billion, Google could buy Uber and its Indian rival Ola and still have enough left over to buy Palantir, a data-mining start-up. Or it could buy Goldman Sachs outright or American Express or most of MasterCard; it could buy Costco or eBay or a quarter of Amazon. Surely it could use those acquisitions to earn more than 2 cents on the dollar.
This strange vogue for corporate hoarding seems to have begun around the turn of the millennium. General Motors is perhaps the most extreme: It now holds nearly half its value in cash. Apple holds more than a third. These numbers are maddening on their face. If the companies spent their savings, rather than hoarding them, the economy would instantly grow, and we would most likely see more jobs with better pay. In the 1990s, when companies saved far less of their profits, they built new factories, bought new buildings. In part because of all that corporate spending, the 1990s were a period of low unemployment and high growth. Remarkably, the United States government was able to tax all that productive corporate behavior so much that it came close to paying off all its debts for the first time in 160 years.
So what is going on now? There are countless economic journal articles laying out theories about why corporations have shifted from borrowing to saving. Some of the reasons are prosaic. Just like people, companies might want to have money for emergencies or for lousy economic times, and the past decade has been a period of increasing risk. Also, corporations have become far more focused on something they call ‘‘tax efficiency,’’ which the rest of us call ‘‘tax avoidance’’: For various reasons, holding on to cash and carefully shifting it among subsidiaries, especially foreign ones, is a great tool to shrink your tax bill.
Another reason to hold on to cash is a byproduct of the increasingly intense competition for talent and acquisitions, especially in technology and pharmaceuticals. When Apple or Google enter negotiations to buy a smaller company, any other firm considering a competing offer may be scared off by their nearly infinite resources. Oddly enough, then, holding on to all that cash might be saving these companies even more money, by allowing them to pay less for the firms they acquire. (Google buys about one company a week, on average; Apple’s acquisitions are more sporadic, but not far behind.)
But even if you accept all these reasons, we are still left with an enormous puzzle. Companies like Google and GM are holding on to far more cash — many times more — than could possibly be explained by emergency funds and tax efficiencies and M.&A. intimidation put together. Lee Pinkowitz, a professor at Georgetown, told me that finance economists agree that there is a puzzle here but break into two distinct camps over the cause. One camp believes that a large cash hoard is a sign of an unhealthy company. Maybe its whole industry is doing so poorly that there is nothing worth investing in; maybe it’s because executives are up to something shady, stockpiling cash as a personal war chest to mask poor decision-making and protect their jobs (cash in the bank, suddenly deployed, can make a firm seem more profitable than it actually is). The other camp doubts that the free market could be allowing executives to hold all that cash if it were purely for their own benefit.
Along with his colleague Rohan Williamson, Pinkowitz built a valuation model that analyzed how investors react to different levels of cash holding. He ran 50 years of data (originally from 1965 to 2004, but then he kindly updated his findings for me, through 2014) for 12,888 different publicly traded companies. The model shows how investors value a dollar of savings when it’s held by different sorts of companies, divided into 43 industry types.
His findings show that both theories have some truth to them. For several industries, hoarding cash is clearly correlated with negative results. When publishing and entertainment companies or aircraft manufacturers hold on to extra cash, investors perceive that money to be worth less than it should, somewhere in the neighborhood of 40 cents on the dollar (the authors make a specific estimate for each industry but also provide a range to account for error). The defense and coal industries are considerably worse, with a dollar in savings valued negatively. This might suggest protective behavior by chief executives in those industries, because the market is clearly not valuing their decision to save.
For other industries, though, a dollar of savings is worth a lot more than itself. For pharmaceutical companies, a dollar in savings is worth $1.50. For software firms, it’s even higher: more than $2. This means that investors are behaving as if they trust the executives in these industries, like Larry Page of Alphabet, to be smarter about using that money than the investors themselves could be. And a cursory scan of the industries in this second group — which also includes automakers, medical-equipment makers and others — correlates well with the ones hoarding the most cash. Corporations, it seems, may have amassed at least a good chunk of that $1.9 trillion in mysterious savings because the stock market is rewarding them for it.
Which leaves one last question: Why? The answer, perhaps, is that both the executives and the investors in these industries believe that something big is coming, but — this is crucial — they’re not sure what it will be. Through the 20th century, as we shifted from a horse-and-sun-powered agrarian economy to an electricity-and-motor-powered industrial economy to a silicon-based information economy, it was clear that every company had to invest in the new thing that was coming. These were big, expensive investments in buildings and machinery and computer technology. Today, though, value is created far more through new ideas and new ways of interaction. Ideas appear and spread much more quickly, and their worth is much harder to estimate. (Indeed, the impossibility of valuing the Internet is essentially what created the 2000 stock bubble.)
Surely the most important economic question of our time is a fairly simple one: Are the good times over? Will wages continue to fall for many, while rising high for a few? In the cash conundrum, we might find a modest reason for optimism. If corporate leaders and their investors truly believed that the future were bleak, that innovation and economic growth were irreparably slowing, there would be little reason to hold on to all that cash. Their hoarding of it hints that they think the next transformative innovation could be just around the corner. If in fact they do — and if they’re right — it’s good news for all of us.
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Let me give credit where it is due: XX has seeded a couple of articles recently that were not brain-dead red meat. (Along with the usual flood of articles that were brain-dead red meat, of course... but still... The improvement may be small, but it is an improvement and needs to be recognized!)
A couple of these articles have touched on economics. Economics is a social science, a great deal more complex than physics which can be defined by a few dozen laws. There are no simple, across the board rules, and trying to reduce these complex topics to bumper-stickers is... foolish...
Corporations are hoarding more cash than ever in history. Explaining that as "government disincentives" is... just plain silly. So... as a gift to XX, here is a thoughtful article on the subject...
Lol. Lol. Economics is more complicated than physics! A few dozen laws!
Thanks for the humor. I've shown your post to some co-workers at the lab, and they thought your views were hilarious.
I suggest you stick to the soft sciences, like economics and astrology.
Hording the cash explanation and waiting for the next transformative innovation is an interesting take on it.
When anyone or any entity hoards cash, it's because they don't feel they have anything that would tempt them to part with that cash, or there might be some kind of disinsentive (is that a word?) to spend it. As touched upon in the article, there are US companies that do large amounts of business overseas, and are taxed in the countries that they do the business. Should they repatriate the funds, they would then be taxed again at the domestic rate. That indicates some level of inefficiency in the tax code. Perhaps there should be a tax on those funds. After all, they are domestic corporations. On the other hand, they were taxed on those earnings already. So maybe there should be some other rate that should be paid in order to bring it back.
The banks have large amounts of cash on their balance sheet. This comes as a result of the new regulations that came after the meltdown in '08. They must have a certain amount on reserve now. Not a bad idea, considering how they proved to be sans swimwear when the tide rolled out.
Is there something big coming? For some, yes. Others, not so much. GM is working on a car for the next generation that will run on something other than petrol. I guess they'll have to do a massive retooling eventually. Alphabet (the company formerly known as Google) is acquisitive from time to time, so they'll be using that somewhere down the line. Apple is a cash machine. I know it sounds like a gross oversimplification, but the more they make, the more they make. They will probably be giving some of that money to the shareholders, only to watch the bank burgeon again.
The article posits a suggestion that some of these companies acquire companies that are in different industries. That reminds me of a transaction that my local utility, Florida Power & Light did about 20 years ago. They purchased an insurance company. They eventually realized that they were good at being a utility, not so much an insurance company. They got out with a few scrapes, and my rates a bit elevated for a couple of years.
It's their money. Let them succeed or fail on their own terms.
"Remarkably, the United States government was able to tax all that productive corporate behavior so much that it came close to paying off all its debts for the first time in 160 years."
Bull crud the nation debt did not decline in the 90's.
Apple has enough cash where they could do a stock buyback large enough to significantly move the value. Carl Ichan has five million shares and is prodding them in that direction. Considering the beating investors have been taking lately it would be a welcome move by many investors.
They spend about $10B a quarter, while cashflow is on the order of $40B.
They have 5 billion shares outstanding. A special $10 dividend would cost them about $50B.
Not a stretch, by any measure.