Why Has the Value of Cash Increased over Time

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Why has the value of cash increased over time? *

Thomas W. Bates Arizona State University Thomas.Bates@asu.edu Ching-Hung (Henry) Chang Arizona State University Ching-Hung.Chang@asu.edu Jianxin (Daniel) Chi University of Nevada, Las Vegas Daniel.Chi@unlv.edu

First Draft: January 2011 This Draft: December 2011

Abstract: The value of cash holdings by U.S. non-financial firms has increased significantly over the past three decades. An additional dollar of cash holdings is valued at $0.61 in the 1980s, $1.04 in the 1990s, and $1.12 in the 2000s. The increase in the value of cash obtains across a variety of firm characteristics, including firm size, the investment opportunity set, financial constraints, and the volatility of cash flow. The general increase in the value of cash can be partially explained by firms that IPO in the 1990s and the 2000s. However, for the 1990s, the increase in the value of cash is predominantly determined by a firm’s investment opportunity set and the volatility of its cash flow. For the 2000s, the increase in the value of cash is largely explained by credit market risk. *The authors thank Sreedhar Bharath, Claudia Custodio, Mark Huson, Shane Johnson, Michael Lemmon, Robert Parrino, and Neng Wang for their helpful comments and suggestions.

Investor concern over the rising cash holdings of U.S. companies has been a consistent focus of the financial press in recent years. 1 The issue of corporate cash holdings has also gained the attention of policy makers. For example, President Barack Obama recently called on U.S. business leaders to spend their corporate cash holdings to spur economic growth, and members of Congress are calling for a tax holiday on repatriated cash.2 Shareholder uneasiness with the increase in corporate cash holdings obtains on two related dimensions: (1) what caused the increased propensity to hold cash, and (2) what is the value of incremental cash holdings for a corporation’s investors. Bates, Kahle, and Stulz (2009) answer the first question. They conclude that the

precautionary motive for cash holdings explains much of the rise in cash holdings observed over the last three decades. In this paper, we address the second question, specifically how investors have valued the rising cash holdings. In a frictionless market, the marginal value of a dollar in cash for shareholders should be exactly one dollar, where the equilibrium cost of maintaining and obtaining that capital reserve just equals the expected benefits associated with that dollar. It is well known that market imperfections can and do cause significant variation in the marginal value of cash for shareholders in the cross-section of firms. For example, Faulkender and Wang (2006) note that variation in the marginal value of cash can be attributed to

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For example, see “Capital Pains: Big Cash Hoards,” by Ian McDonald, The Wall Street Journal, July 21, 2006, p. C1; “Time to Get Off Your Cash? – Companies are content to sit on their cash hoards, but investors are losing patience. What’s a CFO to do?” by Vincent Ryan, CFO Magazine, July 15, 2010; “Companies Cling to Cash – Coffers Swell to 51-Year High as Cautious Firms Put Off Investing in Growth,” by Justin Lahart, The Wall Street Journal, December 10, 2010. p. A1; “Companies Shun Investment, Hoard Cash – Reluctance to Spend by Consumers and Businesses Fearful of a Domestic Slowdown Hamstrings Pace of Economic Recovery,” by Ben Casselman and Justin Lahard, The Wall Street Journal, September 17, 2011, p.A2. 2 “Obama Will Tell Chamber Businesses to Put Cash to Use for Jobs,” by Mark Drajem and Mike Dorning, BusinessWeek, February 7, 2011.

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leverage and the relative tax effects of payout decisions. Dittmar and Mahrt-Smith (2007) demonstrate that quality of corporate governance can have a positive effect on the marginal value of cash. Denis and Sibilkov (2010) find that the value of cash is

increasing in measures of financial constraint. The...
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