Why Do U.S. Firms Hold so Much More Cash than They Used to?

Abstract

The average cash-to-assets ratio for U.S. industrial firms more than doubles from 1980 to 2006. A measure of the economic importance of this increase in cash holdings is that at the end of the sample period, the average firm can pay back all of its debt obligations with its cash holdings; in other words, the average firm has no leverage if leverage is measured as net debt. This change in cash ratios and net debt is the result of a secular trend rather than the outcome of the recent buildup in cash holdings of some large firms, and it is much more pronounced for firms that do not pay dividends and for firms in industries whose cash flows became riskier. The average cash ratio increases over the sample period because firms change: their cash flows become riskier, they hold fewer inventories and accounts receivable, and they are increasingly R&D intensive. The precautionary motive for cash holdings plays an important role in explaining the increase in the average cash ratio; in contrast, in our empirical tests, agency considerations are not successful in explaining the increase.

JEL Classification: G30, G32, G35