The piling up of large amounts of cash and cash equivalents on corporate balance sheets may be negative for the U.S. economy as a whole, but CFOs have definitely embraced the idea.
According to the Duke University/CFO Business Outlook survey for the fourth quarter of 2009, companies on average were holding more cash and marketable securities than they did a year ago — 19.3% of book assets, compared with 17.9% in 2008. The largest increases occurred at AAA-rated companies, which held cash and securities equivalent to 23.2% of book assets, up from 21.9% the previous year. Firms in the A- and B-rated tiers held 16%, up from 12.6% a year earlier.
S&P 500 companies are also guarding liquidity closely: they collectively held $820.3 billion in cash and equivalents at the end of the third quarter of 2009, according to data supplied by Standard & Poor’s, compared with $647.8 billion 12 months earlier. The 2009 number represented 57% of their combined long-term debt, up from 45% the year before.
Before the financial crisis, many would have viewed these levels of cash as excessive. After all, there were too many negatives involved: the cost of carry, the tax expense on interest income, the perception that firms holding too much cash were run inefficiently, and the possibility that a large store of cash would attract unwelcome takeover offers. Now, however, the thinking about cash has shifted. With apologies to James Bond, the financial crisis has given CFOs a license to hold excess cash.
The top motivation for holding large amounts of cash is concern about the overall economic environment, according to 400 finance executives who responded to the question on the Duke/CFO survey. Finance chiefs believe amassing cash is a safety measure. A close second is “need to show investors and banks a healthy balance sheet,” and third is “no good options for putting the cash to use.”
The first motivation, at least, echoes the results of a 2005 survey of CFOs at 204 global firms. Researchers headed by Karl Lins of the University of Utah found that in deciding how much excess cash (cash not needed on a day-to-day basis) to hold, the number-one factor for CFOs five years ago was “cash acts as a buffer against future cash-flow shortfalls.” (Their study, “What Drives Corporate Liquidity? An International Survey of Cash Holdings and Lines of Credit,” will soon be published in the Journal of Financial Economics.)
But second on the list of factors in the Lins study was one that tends to result in less cash held: the “agency-cost view” — that companies (and their management) holding too much cash may not always make the best use of it. That’s in stark contrast to the current “need to show investors and banks a healthy balance sheet.” The agency-cost concern, apparently, has moved to the back burner since 2005.
“Today everyone realizes how hard it is to get cash on good terms, so the presence of a large amount of cash is seen as a sign of strength,” comments Lins. “Investors are less concerned about the agency problem right now. An agency problem is something that slowly puts you out of business, but the lack of cash immediately puts you out of business.”
It also behooves companies to hold larger amounts of cash today because of a decline in what was the dominant form of liquidity five years ago: corporate lines of credit. In the Lins study, firms held a median 15% of book assets in lines of credit — primarily for strategic purposes, to fund future growth opportunities and acquisitions. But today, with banks shrinking credit lines and shortening maturities, and bond markets beginning to push back on new issuances, it’s cash that may have to fund any growth.