Why do large corporations save trillions of dollars?

Illustration by Andrew Rae



There is an economic mystery, which many have been trying to solve for quite some time. Financial experts often call it a puzzle or a paradox. The meaning of this paradox is as follows: American companies collectively possess $ 1.9 trillion in bank accounts and treasury bonds, without using this money in any way. This state of affairs has no historical analogs. American corporations have always been borrowers, not holders of funds, therefore, it is impossible to analyze the source information and compare the current situation with similar periods in the past, such data simply does not exist. But there are several assumptions explaining the reason for the fashion for cash. Answers to the question “why corporations need trillions of dollars?” Can be found further in the translation article of The New York Times Magazine, prepared specifically for the corporate blog of the company processing payments on the Internet, PayOnline .



The very idea that corporations will hold such a large part of their profits seems to be absurd for economic reasons, especially now that the treasury bonds in which they hold this money give only 2% of the profits. It would be much more profitable to invest them in something else - products, services or the acquisition of other companies. This would allow exceeding the minimum corporate profitability of 2 cents per dollar. However, they prefer to keep this money.



Take, for example, Google. His new parent company, Alphabet, is worth about $ 500 billion. She owns the amount of 80 billion dollars, which holds on Google bank accounts or other short-term investments. Therefore, buying 1 share of Alphabet, which recently traded at about $ 700, you actually get at your disposal $ 100 in cash. With the help of these $ 80 billion, Google could buy Uber and its Indian competitor Ola, and spend the remaining money on Palantir, a startup working in the field of data analysis and presentation. Or, with the help of this money, Google could easily buy Goldman Sachs or American Express, or almost a 100% stake in MasterCard. Another option is to buy Costco or eBay, or a 25% stake in Amazon. In general, Google has all the possibilities to invest these funds and as a result get much more than just 2 cents from the dollar.

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Apparently, the beginning of this strange fashion of corporations for hoarding came at the beginning of the 2000s. The most striking example is General Motors, which holds cash in the amount of almost half its value. Apple holds more than a third of its value. Of course, not everyone can come to terms with this state of affairs: if companies instead of accumulating funds in this way, let them go, we would immediately see a sharp economic growth, and with it surely an increase in the number of highly paid jobs. In the 90s, when companies retained a much smaller part of their profits, they built new factories and acquired new buildings. Partly because of this habit of letting money into the business, these years turned out to be the period of the lowest unemployment rate and tangible economic growth. It is also noteworthy that this useful model of corporate behavior has helped the government to collect such a large amount of tax collections that for the first time in the last 160 years it has come close to paying all its debts.



What is the reason for this behavior? The number of articles on this topic in economic journals is not countless. Each offers its own theory of why corporations have moved from borrowing to saving them. Some give quite prosaic reasons: just like people, companies want to have money for emergency cases or stay afloat during bad economic periods, and the past decade has not been calm due to increased risks. In addition, corporations have begun to pay much more attention to the so-called tax optimization, which everyone else calls "tax avoidance." There are many reasons why keeping money and distributing it carefully among subsidiaries, especially foreign ones, is an excellent way to reduce the amount of taxes paid.



Another reason for keeping money is related to the ever-increasing competition for getting the best staff and buying promising companies. This is especially true for high-tech companies and the pharmaceutical industry. When Google or Apple enter into negotiations for the purchase of smaller companies, they can scare other competitors, because the latter understand that they are entering into an unequal battle with the owners of virtually infinite resources. It turns out to be a rather strange situation, when retention of money helps companies to save even more of them due to the opportunity to pay less for takeover in the absence of competition. Google, by the way, buys one company a week, while Apple, despite the less regular nature of its acquisitions, generally does not lag behind its rival.



But even if you are satisfied with these explanations, the mystery still remains unsolved. Companies like Google or GM are holding too much cash. So much so that even a reserve fund, tax optimization and scaring competitors together can not be an excuse. A professor at Georgetown University, Lee Pinkowitz, says that economists who recognize the ambiguity of this issue are divided into two different camps.



Representatives of the first camp believe that a large supply of cash signals the presence of serious problems in the company. It is also possible that things are going badly for the entire industry, so much so that its representatives simply have nothing to invest in. Perhaps the fact is that top managers are engaged in their dark deeds and accumulate such “stashes” to achieve personal goals. For example, they want to hide the consequences of wrong decisions for the sake of saving their posts. In this case, they can use the money supply, temporarily making the company more profitable.





Illustration by Andrew Rae



Representatives of the other camp doubt that the free market is capable of creating opportunities that would allow managers to hold such large amounts of cash for their own purposes.



Together with his colleague Roan Williamson, Pinkowitz created an appraisal model that allowed analyzing investors' reaction to different levels of cash savings from companies. The data of 12888 open joint-stock companies from 43 industries for the period from 1965 to 2014 were analyzed. The model shows the value of investors valuing $ 1 invested in a particular company.



The data obtained by him show that both theories are grounded. For some industries, cash accumulation obviously correlates with negative results. For the publishing business and the entertainment industry, attempts to accumulate additional cash reserves mean that this money loses its value in the eyes of investors, falling in value to 40 cents per dollar. In the defense and coal industries, things are much worse: the value of one dollar invested falls below zero. Perhaps this means that company leaders in these industries are trying to create a safety cushion for themselves or their companies, since the market obviously reacts negatively to their desire to accumulate money supply.



However, in the case of other industries, the value of each dollar invested increases as a result. For pharmaceutical companies, the value of one dollar of such savings grows to $ 1.50. For software companies, this figure is even higher - $ 2. This attitude of investors means that they trust the heads of companies in these industries, such as Larry Page, who heads the Alphabet. In fact, investors believe that the management of such companies can use capital even better than themselves. A superficial study of the second group of industries, including, among others, automobile companies and manufacturers of medical equipment, shows that the number of companies accumulating the most funds correlates with their affiliation with these industries. It is possible that a decent part of the above-mentioned amount of 1.9 trillion dollars belongs to the corporations that have accumulated them, in order to receive remuneration from the securities market.



As a result, there is only one question: Why do companies do this? The answer, perhaps, lies in the fact that both managers and investors believe that big changes are coming in their industries, but what kind of changes this will be, no one knows for sure. Throughout the 20th century, as humankind passed from horse and sun agrarian to electrified and motorized industrial, and then to silicon-based information economies, it became clear that investing in innovations helped the majority of companies to doing it. This is a major investment in the acquisition of buildings, equipment and computer technology. Today, however, the value of companies is growing more at the expense of new ideas and ways of interaction. Ideas appear and spread much faster than before. Estimate their cost while becoming more difficult. As a vivid example of this trend, we can cite the “dotcom crisis”, which also occurred due to the inability of companies to give a correct estimate of the value of the Internet market.



Of course, the main economic questions of our time sound very simple: “Has the auspicious times passed? Are we waiting for an increase in the gap between the rich minority and the less well-off majority? ”The money puzzle gives us a little reason for optimism. If corporate leaders and their investors truly believed that the future would be bleak, and innovative and economic growth inexorably slowed down, they would have little reason to keep so much money. In fact, this accumulation may be a sign that the following innovative changes are just around the corner. And if this is true, then soon the good news awaits us all.