The Real and Financial Effects of Internal Liquidity: Evidence From the Tax Cuts and Jobs Act

Abstract

The Tax Cuts and Jobs Act removed the repatriation tax on the accumulated foreign profits of U.S. firms, effective January 1, 2018. Overnight, this unlocked as much as $1.7 trillion in new liquidity for U.S. multinationals. Using a difference-in-differences approach, we examine the real and financial response to this liquidity shock. We find that firms did not increase capital expenditures, employment, R&D, or M&A in response to the increased access to cheap capital, regardless of financial constraints. On the financial side, firms responded to the increased liquidity by increasing share repurchases and adjusting downward consolidated cash holdings. However, less than one-third of this new liquidity was paid out to shareholders, and half of it was retained as cash. This high retention was not associated with poor governance. Our findings suggest a low sensitivity of financial positions in response to liquidity shocks even among well-governed firms with limited financial constraints.

Keywords: Corporate liquidity; Corporate cash holdings; Tax Cuts and Jobs Act (TCJA); Corporate investment; Mergers and acquisitions; Corporate income tax; Multinational corporations; Worldwide tax system; Repatriation tax

JEL Classification: G31, G32, G34, G35, F23, H25