An Alternative View on the Corporate “Cash Hoard”

There’s been a lot of chatter in recent days (see Paul Krugman for instance) about the corporate cash hoard and how the economy would be humming if corporations were putting all this cash to work.   The thinking is generally based on the understanding that corporate profits are soaring, but the corporations are just sitting on all this cash as if there’s nothing to do with it (Apple’s particularly healthy balance sheet gets the majority of the press coverage and scrutiny, but doesn’t provide nearly the full picture).  But a different take explains why this might be occurring – maybe corporate America isn’t as well off as we all believe.

It’s true that corporate profits are booming, but that doesn’t put the full balance sheet into perspective.  While corporate profits are booming, debt relative to corporate net worth is actually still very high.  In fact, corporate debt relative to net worth is just shy of recent highs and still extremely high in terms of the last 50 years.

Now, this doesn’t mean corporations are necessarily so weak that they can’t spend and invest, but it does throw some cold water on the idea that corporate America is benefiting from the recent surge in profits and just refusing to contribute to the recovery.

The reality is that corporate America is more fragile than most believe and the lack of strong aggregate demand gives them good reason to be cautious about their balance sheets.

(Chart via Orcam Investment Research)

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://noahpinionblog.blogspot.com Noah Smith

    So why don’t corporations pay down their long-term debt instead of holding short-term marketable securities?

  • Johnny Evers

    One theory is that corporations remember 2008 when they lost access to credit, so they are borrowing now and using that cash as emergency money.

  • Kafkaesque

    I’m confused. Why would high corporate debt as a % of net worth be indicative of fragility, rather than indicative of CFOs’ desire to drive down cost of capital by issuing debt at incredibly low rates?

  • Frederick

    I think you’re overestimating the impact of reducing borrowing costs, no? A change in the term structure of their debt doesn’t mean they’re going to necessarily spend and invest more, does it?

  • LVG

    More likely, they’re refinancing at lower rates.

  • jswede

    your comment answers the question above…

    however the point is that much of the cash on the left side of the balance sheet is reconciled on the right side as debt, not retained earnings, as MSM would like to have you think

  • Tom Brown

    I’m confused by your comment. So a CFO issues debt, even at incredibly low rates, unless they do something with the proceeds of the debt issuance with a greater return than those “incredibly low rates” how does that help them? Are you suggesting that they pay less than IOR for their debt?

  • Tom Brown

    Sorry, that was not directed to you jswede, but to Kafkaesque.

  • Pragmatic Liberal

    @Noah, because they tend to have higher interest rates on short-term marketable securities than debt. Households, especially lower-income ones, tend to have higher interest rates on their debt, so they are more motivated to pay it down rather than accumulating savings to offset debt. You will find that households that earn more interest on investments than they pay interest on debt will often accumulate savings rather than paying down their debt.

  • Johnny Evers

    I had the same thought as jswede.
    When you read the MSM, you get the impression that corporations are just swimming in profits, but are greedily refusing to share that money with workers.

  • Anonymous

    Raise the corporate tax rate. Corporations will payout cash hoards in salary. The secret sauce is wages!!!!!!

  • http://www.orcamgroup.com Cullen Roche

    JKH has some thoughts along the same lines.

    http://monetaryrealism.com/krugman-on-says-law/

  • http://bubblesandbusts.blogspot.com Joshua Wojnilower

    Good post Cullen. I’m always surprised that discussions of cash on the balance sheet never seem to include any mention of debt on the other side. Quick question, is there a reason why you chose to show corporate debt relative to net worth instead of GDP?

    Separately, but related to the cash hoarding debate, I recently found that undistributed corporate profits have risen significantly since the financial crisis ended (http://bubblesandbusts.blogspot.com/2013/02/inequality-really-is-holding-back.html). As the charts shows, undistributed corp. profits were actually trending higher prior to the crisis. IMO this lends support to the view that corporations are holding earnings abroad to avoid taxes and borrowing at home to fund current investment/operations.

  • Kafkaesque

    @Tom, what I meant was that company projects have a hurdle rate for return on capital, and the lower the cost of capital goes the more projects can be undertaken. But in an environment of anemic demand, hurdle rates drop as well. So I would think the prudent thing to do would be to lock in a low cost of capital for when hurdle rates rise. In this case, I would think high cash balances would indicate preparation (or “dry powder”) rather than fragility.

    But I’m no CFO and could be completely off base.

  • JKH

    My post is more round about than yours, Cullen, in an attempt to bite off in quick fashion several big points that have come up in Krugman land over the past few years. But your post is a perfect example of one thing I was driving at – which is that the association of large cash hoards with corporate profits, while having some merit, may be a bit too simplistic on its own. Corporate treasurers develop their cash strategies by looking at their overall balance sheet condition and composition, in the same way that you have.

  • Geoff

    Interesting chart. I thought recessions were supposed to times of de-leveraging. Did corporations really re-lever that sharply during the last recession?

  • jaymaster
  • http://www.orcamgroup.com Cullen Roche

    I did it relative to NW to get a more granular view of the corporate sector specifically.

    The repatriation argument makes sense. I don’t discount it. I just think we have to keep things in perspective when we consider WHY corporations aren’t doing more. In fact, I think we could even say, because we’re in a BSR, that the corporate sector is more than pulling its weight because they’ve actually been leveraging up (like the govt) when households weren’t….

  • jwr

    Hussman touched on this over a year ago: http://www.hussmanfunds.com/wmc/wmc111128.htm

  • Anon

    I certainly agree with Johnny that there’s companies raising cash via debt issuance (at good rates!) for a “rainy day”.

    Another major factor is “financial engineering” – “return on equity” is a very popular metric used to gauge the performance of a business. Quite simply, the more debt a profitable business has, the better the ROE. If your “return on assets” is greater than your cost of debt finance, you’re encouraged to gear until the bank/bond market catches on to your financial position and demands higher rates.

    (An example from an investors perspective – if you’re confident you can deliver an 8% return in this wonderful bull market and you can borrow for 4%, you’re encouraged to go to the abnk and ask to borrow $10M)

  • LVG

    JKH, that is one awesome post. Thanks.

  • Very Serious Sam

    “you get the impression that corporations are just swimming in profits, but are greedily refusing to share that money with workers.”

    Which would create/fuel a vicious circle, since AD doesn’t increase as long as the workers don’t get a higher disposable income.

    If so, the increasingly disbalanced distribution of wealth and income would be real issue to be addressed to get out of the BSR.

    What’s MR’s take on this?

  • Explorer

    Maybe the debt is in subsidiaries in jurisdictions with high tax rates and the assets (cash, securities) are in subsidiaries in jurisdictions with low tax rates.

    Think about the use of tax havens to hold intellectual property building up cash while subsidiaries in higher corporate tax jurisdictions reduce profits by transfer pricing of intellectual property rights to the low tax jurisdictions.

    There are two main things, building up cash in low tax jurisdictions and minimising operating profits tax in high tax jurisdictions.

  • Sam A

    Would be interesting to see the same data ex financials. How much of the rise between 2008 and 2010 in debt to net worth was due to equity erosion in financials versus additional borrowings from non financial corporates?

  • Supply and Demand

    Does your rock come with electricity and running water?

    QE does not create demand, just liquidity.

  • Tom Brown

    I had to look up “hurdle rate” but I see what you’re saying now.

  • http://bubblesandbusts.com/ Joshua Wojnilower

    In relation to GDP, it appears nonfinancial corporate debt is approaching its all-time highs near 55%. This corresponds with increasing net interest payments by that sector. If one views interest as a form of operating cost for businesses, this could help explain why the economy has maintained a positive inflation rate despite the BSR. Any thoughts on this type of cost-push inflation theory?

  • http://www.nowandfutures.com bart
  • Bruce

    Cullen, I shared your article on another site. One reader commented as follows: “I read the article by Cullen Roche to which you linked, and I am having problems with his assertions about the weaknesses of corporations based on debt to net worth being the possible reason for cash hoarding. Roche does provide a graph that shows debt to net worth soared, and has since come down. But he does not provide specific details to support his assertion. As I read the graph, debt to net worth (in billions of dollars) was at slightly below 0.30 in 1980, rose above 0.50 by 1990, continued to climb above 0.55 between 1990 and about 1995, began to drop until about 2008. It spiked greatly during the Great Recession and is now lower than it was in 2001. So, if the debt to net worth was higher between 1990 and 1995, then wouldn’t that be the period when companies would have held more cash? Roche doesn’t discuss that or make comparisons between any paticular years. Maybe that is not what he does, but it just seemed odd to me that he makes an assertion that it is debt to net worth without giving examples on how much cash companies held during a higher debt to net worth.” Comments?

  • Greg

    Cullen

    When you talk about the corporate debt levels are you referring to the amounts they owe to bondholders or the amounts they owe to banks….. or both?

    I can understand how they might have seen an increase in corporate paper issuance as some people diversify away from low yielding treasuries but I dont understand why they would be taking out more bank loans as that is usually a sign they are expecting future growth to pay back that debt.

    If its more corporate paper issuance isnt that just a zero sum game? Dont the funds for that paper come from the non corporate sector and represent a reallocation of prior saving?

    If it is just more corporate paper, I think that lends credence to your idea that they arent doing as well nor expecting to. They are just taking the non corporate sectors cash issuing a bond for it and paying back quarterly interest. They arent growing nor expecting to, they are just treading water.

  • Anton

    Net debt to EBITDA, net debt per share, debt to assets and debt to equity are at the lowest level since 1999 – Bloomberg data of the corporates comprising the S&P index. I don’t think you can explain the high cash levels with the level of corporate debt.

  • Mark Thompson

    I suggest reading the study found here

    http://www.sungard.com/cashinvestment

    for an answer to your question. Along the way, please note that most corporates have experienced no substantial increase in cash.

  • Mark Thompson

    Here is a presentation by the BEA datakeepers who keep tabs on corproate profits. Look at slide 9 and you will see that there isn’t much “corporate cash hoarding” going on at all. All profits generated in a year are paid out to investors, taxed away or reinvested.

    http://nabe-web.com/cem2011/documents/Krakower.pdf

    I think, if cash is building up somewhere, it is cash that is outside of the BEA GDP realm, probably a result of financial activity that itself is probably a consequence of the Fed’s quantitative easing, at a macro level, although it may wind up not entirely infinancial institutions. In addition, as someone who works in a multinational operation, as you grow overseas, your minimum cash needs go up dramatically because you have to maintain liquidity in so many more currencies and bank accounts in so many more locations.And that has certainly been a growing trend.

  • Mark Thompson

    Another useful analysis is found at
    http://businessfinancemag.com/article/corporate-cash-reach-all-time-high-sort-0626
    which supports the thesis that corporates have simply taken advantage of low interest rates to raise long term capital in the cheapest way possible. The Fed has driven this by monetizing the government debt and leaving long term debt holders in need of new places to invest which has caused them to offer low coupon debt to the corporate sector.

    As well, there is no “hoarding” going on. If you look at the S&) 500, cap ex has been growing much faster than GDP for most of the lat three years. They have just taken advantage of low interest rates to raise funds for these in advance.

    Basically, corporates are participating in the Fed’s game plan.