Is Cash Still King?
According to Moody’s Investor Services, U.S. non-financial companies held about $1.7 trillion in cash in 2016. Corporate cash holdings have more than doubled in the last 10 years, attracting the attention of activist investors, the public and academics, alike.
“Many view cash hoards as controversial because they give managers leeway to invest, possibly in less productive activities,” said Paul College associate professor of finance Yixin Liu.
Studies have shown that markets react negatively to mergers and acquisitions announcements when the acquiring firm carries large amounts of cash. The prevailing wisdom holds that these cash-rich companies lower their value through M&As. “My research overturns this general perception,” said Liu, the prize-winning co-author of “Corporate Cash Holdings and Acquisitions.”
Liu’s groundbreaking study, published in the journal Financial Management this year, won the 2015 Annual Conference on Global Economics, Business and Finance Best Paper award. It is the latest addition to a robust research portfolio that has appeared in top-tier journals.
Examining M&A data involving more than 2,700 companies from 1985 to 2015, Liu discovered that negative market reactions to an acquiring firm’s announcement of an acquisition were far from “universal.” Instead, the method of acquisition determined market reactions.
“I found that negative reactions were limited to stock payment acquisitions by firms with large cash holdings, and that firms paying cash to acquire other firms did not face negative reactions,” she said.
Larger cash reserves give companies greater flexibility to choose their payment method than that available to firms tight on cash. Thus, cash-rich companies that acquire others through stock purchases are effectively, if not deliberately, “signaling” to the market that the shares are overvalued, leading to a price drop. The possession of “unproductive” cash does not, in itself, lower an acquiring firm’s perceived market value.