Why Are Corporations, Especially in Tech, Hoarding Trillions in Cash?

Is this a sign that executives currently believe the returns to cash are greater than the future returns to investment in innovation? 

The bigger question may be why their fears seem to be dominating their greed - and which may explain why capital markets are skittish and activist investors are saying, in effect, 'if you're too frightened to spend it, we'll take it,' even from companies like Apple. JL

Adam Davidson reports in the New York Times:

With $80 billion, Google could buy Uber and its Indian rival Ola and still have enough left over to buy Palantir. Or it could buy Goldman Sachs or American Express or Costco or eBay or a quarter of Amazon. Surely it could use those acquisitions to earn more than 2 cents on the dollar. General Motors now holds nearly half its value in cash. Apple holds more than a third.

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.

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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.