Why Are Corporations Holding So Much Cash?

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Letter Writer:

James Morgan of Ann Arbor, retired economics professor at the University of Michigan

Date Posted:

Feb. 15, 2013

Letter:

The article by Sanchez and Yurdagul attributes the vast cash holdings of corporations to uncertainty and precaution, credit constraints and tax avoidance. This fails to speak of another possibility—inadequate aggregate market demand stemming from four leakages, one being the massive increase in income inequality: the larger fraction of income going to a small fraction at the top, with individual incomes so high they could not be expected to spend more than a fraction on anything that provided jobs. This weakness in aggregate demand left corporations with few promising new investment opportunities; so, they sat on cash or bought up other companies, the second even increasing unemployment.

   

Letter Writer:

Lee Minton, investment manager in Sparta, N.J.

Date Posted:

Feb. 5, 2013

Letter:

Wouldn't the quick ratio give you a closer look at the question? You might be mixing an increase in working capital with a desire to hold cash. Has this been looked at? So, what we want to find is the excess over the normal or even trend quick ratio.

Letter Writer:

Richard Hodde, retired partner of WEDGE Capital Management in Charlotte, N.C.

Date Posted:

Feb. 5, 2013

Letter:

Investment analysts have been using the amount of cash on corporate balance sheets as a measure of financial strength. The article seems to support this thinking by use of the chart relating cash to assets. From the standpoint of financial strength, however, it would seem appropriate to also analyze cash to debt.

Author's response to these two letters:

Thanks for your questions; they are very relevant. The "quick ratio" is the ratio of what we refer to as cash in the article to the current liabilities. It measures the ability of a company to use its cash to retire its current liabilities immediately. In the article, our concern was why corporations hold so much cash, but we focused on a measure referred to as cash-to-net assets ratio, which is obtained by dividing aggregate cash and equivalent assets by aggregate total assets minus cash and equivalent assets.

I totally agree that what we are interested in the article is abnormal cash holdings. We actually mentioned that the work of Pinkowitz, Stulz and Williamson considered a measure of "abnormal cash holdings," defined as the difference between the cash holdings of firms predicted using their patterns in the late 1990s and their actual cash holdings in subsequent periods. They showed that abnormal cash holdings of U.S. firms are significantly larger than those of foreign firms.

   

Letter Writer:

Raymond Lombardo, managing partner/CEO of investment advisers Clearview Investment Partners LLC in Newport Beach, Calif.

Date Posted:

Feb. 5, 2013

Letter:

I've always thought a good study would look at the margin requirement for derivative transactions for currency and interest rate instruments. Multinationals use these more and more to smooth earnings and risk in overall operations. The requirement forces cash to be held to secure such transactions, and just a quick perusal of Microsoft's 10K reveals as much. The growth of derivatives over the study period should help explain at least some of the cash accumulation.

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