The Liquidity Trap: Hard Choices for CFOs

Liquid Money
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The Federal Reserve reports that nonfinancial corporations held $1.7 trillion of liquid assets. That's cash and securities that could easily be converted to cash.

That is a lot of cash. Why are corporations so flush? Because profits have been rising. For example, the S&P 500 will report record profits for the fourth quarter of 2012. Total dollar profits for the S&P 500 in 2012 were $920 billion, according to S&P Capital IQ, an increase of almost 21 percent from $769 billion in 2010.

Bigger profits don't necessarily mean more cash, but in this case, it does. That's because most of the other things companies spend that cash on — capital expenditures, mergers and acquisitions, and wages — are not growing as fast as profits. True, many corporations upped their dividends in 2012, but regardless: The corporate cash hoard got bigger.

(Read More: Why Pressure's Building for Firms to Part With Cash)

Next question: what are they going to do with all that cash?

I spoke with John Graham at Duke University, who does a regular survey of CFOs in conjunction with CFO Magazine. In the most recent survey (mid-2012) of some 700 respondents, about half said they would hold on to the cash, and half said they had plans to spend at least part of it in 2013.

Why are half the companies not planning to use any of their cash? Three main reasons were given:

  1. They needed it as a "liquidity buffer" (46 percent of respondents).
  2. They needed to hold cash until economic uncertainty declines (36 percent).
  3. There were no attractive investment opportunities (19 percent).

One additional item is missing from the list: Companies are not spending cash because many of the profits from large companies are "trapped" overseas and cannot be easily repatriated. The U.S. allows offshore cash from multinationals to accumulate untaxed, as long as it is held by off-shore subsidiaries. Graham told me that this does show up on the list, but fewer mentioned it because many of the companies that respond to the surveys are not multinational.

(Read More: Corporate America: Tax Me If You Can)

He acknowledged that cash can be trapped overseas and contribute to the increased cash holdings of multinationals. Indeed, a survey of multinational companies by Deloitte indicated that many CFOs report keeping almost a quarter (24 percent) of their cash overseas — and the real number may be even higher.

There are also notable differences in the answers based on size: Smaller firms were more likely to say they were accumulating cash, and bigger firms were more likely to say they would spend. Cash as a percentage of assets for larger companies was roughly 10 percent, where for smaller firms it was higher — about 16 percent, a historically high figure.

Why the difference? Smaller firms are more interested in hoarding because they have less access to borrowing.

Of those that said they would spend money, the most common expenditures, in order of most cited, were:

  1. capital expenditures, such as a new facility (60 percent of respondents);
  2. acquisitions (40 percent);
  3. pay down debt (26 percent);
  4. increase hiring (25 percent);
  5. increase dividends or share repurchases (19 percent).

Compared to prior years, more reported that they would be doing acquisitions, and more reported that they would increase hiring. That's good news.

Still, what sticks out is that half the companies have no plans to spend their cash hoards. At all.

Why? First, we should take them at their word: the two biggest explanations — a "liquidity buffer" and the need to hold cash in uncertain times — are essentially the same answer. Corporations are still spooked after 2008, and still have little confidence in Washington.

There's another, even more likely, explanation, at least among publicly traded companies: There is not a lot of pressure from shareholders to do something. There are no signs of massive shareholder revolts.

True, you have a select few shareholder activists like David Einhorn going after Apple — which has almost a third of its market share in cash — but outside of a few high profile one-off cases I don't see shareholder revolts.

(Read More: Forget the CEO? Why CFOs May Be More Important)

Why not? First, there is some logic to the idea of holding cash in uncertain times. It's not a crazy idea.

Second, equity markets are doing well! That placates an awful large number of investors. It's hedge fund guys such as Einhorn who need leverage that are pushing for more. If the stocks weren't doing well, the returns would have to come from yield. That would be a problem for companies because investors would not sit still for very long with returns solely from dividends of, say, 1.8 percent, which is the dividend return on the entire S&P 500 right now. Stocks are way too risky to hold for returns like that. You can buy short-term corporate bonds, which are much less risky, for that kind of yield

Finally, you may be wondering: Where do they keep all that cash? A survey done by Deloitte indicates that about 60 percent park all or some of the money in Treasurys, while about 50 percent use bank deposits and money market funds. Far fewer use corporate bonds (19 percent) or commercial paper (9 percent).