What has driven the dramatic rise in U.S. corporate cash? Using non-public data, we show that the
run-up is not uniform across firms but is concentrated in the foreign subsidiaries of multinational
firms. Standard precautionary motives explain only domestic cash holdings, not these burgeoning
foreign cash balances. Falling foreign tax rates, coupled with relaxed restrictions on income
shifting, are the root of the changing foreign cash patterns. Firms with intellectual property have
the greatest ability to shift income to low tax jurisdictions, and their foreign subsidiaries are where
we observe the largest accumulations of cash.
According to recent Flow of Funds estimates, U.S. non-financial corporations are sitting
on an aggregate cash and marketable securities position of close to $4 trillion (see Figure 1). This
staggering amount has led policy makers and commentators to express concern as to why firms
are building such large stockpiles. To explain the dramatic rise in cash, it is first necessary to
understand the factors that cause firms to hold cash.
In a world of capital market frictions and uncertain investment opportunities, holding cash
enables firms to invest in value creating projects without delay. This precautionary savings story
has been the primary focus of the academic literature. Earlier work focused on measuring firms’
access to the capital markets (Opler et al., 1999), while more recent work has focused on the role
of increasing investment uncertainty (Martin and Santomero, 1997; Boyle and Guthrie, 2003;
Bates, Kahle, and Stulz, 2009; and Harford, Klasa, and Maxwell, 2014).
Not all cash is held for precautionary savings. Thus, uncertainty and financing frictions
alone may not explain the huge run-up in corporate cash. Foley et al. (2007) and Graham and Leary
(2017) explore foreign taxes as an alternative explanation for why firms hold cash. The United
States taxes the income of foreign subsidiaries, but only when the income is repatriated.1 Thus,
when the foreign tax rate is less than the U.S. rate, there has been an incentive to delay repatriation
(Faulkender and Petersen, 2012 and Graham, Hanlon, and Shevlin, 2010). Firms’ objective to
minimize the present value of taxes may result in a buildup of cash in foreign subsidiaries – often
called “trapped cash.” Foley et al. (2007) show in a cross-sectional time-series regression that
lower foreign tax rates are associated with higher total and higher foreign cash.
Our research bridges these two distinct explanations. The literature has characterized investments in intellectual property (R&D) as being more opaque and therefore contributing to the demand for holding cash to fund future investments. Observing that the cash run-up is most acute at high R&D firms has given rise to the precautionary savings interpretation. Alternatively, the opacity of intangible assets may better facilitate income shifting to low tax countries. If so, the tax explanation would be more accurate.
To explore the immense growth in corporate cash, and to differentiate between the alternative explanations of that growth, we focus on where the cash is located. Theoretically, location matters. Foreign and domestic cash are perfect substitutes when the tax rates are equal and there is no incentive to delay repatriation. However, as foreign tax rates fell below U.S. rates, there has been an incentive not only to delay the repatriation of foreign income, but also to shift income into lower tax jurisdictions.
The empirical challenge is that observing domestic and foreign cash historically has not been possible using publicly available data sources. While some firms recently have voluntarily disclosed their foreign cash position (Harford et al. 2017), this selectively released data is limited in both scope and length. The Bureau of Economic Analysis (BEA) conducts a mandatory survey of U.S. multinational companies that generates the data that is needed to address this shortcoming. From this survey, we are able to measure the amount of cash and marketable securities that firms are holding in each foreign subsidiary. Combining this with the disclosure of their total cash and marketable securities position (from Compustat), we are able to calculate how much cash is held domestically.
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