Why are Corporations Hoarding Trillions in Cash?

Corporate America is flush with cash! Collectively, the Amazons’, Apples’ and other such publicly traded mega corporations account for close to $2 trillion in cash. This excessive hoarding of cash in unparalleled in financial history and hence has left a lot of economists flummoxed.

In this article, we will try to understand why American corporations are holding on to piles of cash instead of investing it.

The Problem with Piles of Cash

Financial and non-financial firms hold cash for very different reasons. It is not unusual for financial firms to hold on to a lot of cash. Hence, in order to be fair, it is important that only the cash holdings on non-financial firms are being considered in this article. However, that does not seem to make too much of a difference since non-financial firms account for $1.6 trillion of this cash pile.

Huge cash piles have traditionally been considered to be a problem for the company holding them. This is because if a company is holding a lot of cash, it means that the company is holding less of other assets. The problem with cash is that in the short run, the yield is abysmal. If cash is held in a savings account or a money market account, the yield is negligible. In some cases, the yield may even be negative. Therefore, normally, companies do not hold much cash since it depresses their own return on equity.

However, hoarding cash is bad for the overall economy as well. The stockpiles of cash being held by Amazon or Apple could be used by small businesses to meet their liquidity needs. By holding on to huge sums of cash, these corporate giants are preventing the circulation of cash and reducing the velocity of money. When the velocity of money reduces, the result is seen in slower GDP growth. Hence, it would be fair to say that American multinational corporations are withholding the growth of thousands of small businesses worldwide.

Why are American Companies Holding this Cash?

According to economic theory, there are only two reasons to hold on to cash:

1. First is the transaction motive. If companies are afraid that they may not be able to raise funds when needed, they tend to hoard cash. This allows them to be less dependent on banks and other financial institutions. The fact that recession may just be around the corner gets a lot of companies worried about their finances. Excess cash allows the firms to be self-sufficient and avoid the resultant stress. However, only a small amount of cash is required for this purpose. There is no need to hoard $1.6 trillion for purely transactional purposes. Hence, it would be safe to assume that most of the cash being held in corporate vaults is not for self-defense.
2. The second and most likely reason to hold on to large amounts of cash is tax avoidance. A large chunk of this $1.6 trillion cash is being held by American corporations in offshore accounts. As per the current tax law, American corporations are supposed to pay tax on the income that they generate all over the world. However, this tax only becomes payable when the money is repatriated back to America. American corporations are using this provision as a loophole. They are not transferring the cashback to America. As a result, they are indefinitely deferring the tax payment by keeping the money stashed abroad. If these firms want to invest money in any other country apart from America, they can mobilize the funds directly to the destination and avoid paying taxes in America altogether.

The Argument for a Tax Holiday

This big stockpile of American cash has been a lot in the news lately. As a result, it has tempted many American lawmakers to argue that a tax holiday should be provided to these corporations which are already worth billions of dollars. According to these lawmakers, there should be a fixed period of time when companies should be allowed to repatriate their cash without having to pay any taxes. They believe that this will spur more investments in America and lead to more job creation.

The problem is that American corporations are already known for paying painfully low amounts of tax. Companies like Amazon have a bad reputation since people believe that they earn billions but don’t pay any taxes. Hence, convincing the American taxpayer to provide another tax holiday is going to be a difficult task.

On top of that, there are several American corporations which have actually done the opposite. Many corporations have taken tax holidays and reduced their workforce instead of increasing it. For instance, pharmaceutical giant Merck was allowed to repatriate close to $6 billion tax-free in 2005. However, within a year, the company fired more than 4000 American workers! Similarly, other companies such as Hewlett Packard have also fired 15000 personnel after getting a tax holiday over an income of $15 billion.

It is high time that the government stops succumbing to corporate blackmail. American companies are obliged to report their incomes in America. The government should change the tax laws to ensure that a big chunk of this cash is either invested or repatriated back to America.

❮❮   Previous

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.