Principles of Corporate Finance_ 12th Edition

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Chapter 29 Financial Planning 761


bre44380_ch29_759-786.indd 761 10/08/15 10:49 AM


customers pay their outstanding bills. Short-term securities can generally be sold if the firm
needs cash on short notice and are therefore more liquid still.
Whatever the motives for maintaining liquidity, they seem more powerful today than they used
to be. You can see from Figure 29.2 that, particularly in the easy-money years before the financial
crisis, firms in the United States increased their holdings of cash and marketable securities.
Some firms choose to hold more liquidity than others. For example, many high-tech com-
panies, such as Intel and Cisco, hold huge amounts of short-term securities. On the other
hand, firms in old-line manufacturing industries—such as chemicals, paper, or steel—manage
with a far smaller reserve of liquidity. Why is this? One reason is that companies with rap-
idly growing profits may generate cash faster than they can redeploy it in new positive-NPV
investments. This produces a surplus of cash that can be invested in short-term securities. Of
course, companies faced with a growing mountain of cash may eventually respond by adjust-
ing their payout policies. In Chapter 16 we saw how Apple reduced its cash mountain by pay-
ing a special dividend and repurchasing its stock.
Many companies, including Apple, have businesses located in countries with low rates of
corporate tax. Since profits are not taxed in the U.S. until the companies repatriate them, there
is a powerful incentive to let the cash build up abroad. Some companies with unusually high
cash mountains hold their cash in tax havens. As we pointed out in Chapter 1, this practice of
tax inversion has generated considerable criticism.
There are some advantages to holding a large reservoir of cash, particularly for smaller
firms that face relatively high costs of raising funds on short notice. For example, biotech
firms require large amounts of cash to develop new drugs. Therefore, these firms generally
have substantial cash holdings to fund their R&D programs. If these precautionary reasons for
holding liquid assets are important, we should find that small companies in relatively high-
risk industries are more likely to hold large cash surpluses. A study by Tim Opler and others
confirms that this is, in fact, the case.^2


(^2) T. Opler, L. Pinkowitz, R. Stulz, and R. Williamson, “The Determinants and Implications of Corporate Cash Holdings,” Journal of
Financial Economics 52 (April 1999), pp. 3–46.
0
2
4
6
8
Cash as percent of assets
10
12
14
198019821984198619881990199219941996199820002002200420062008201020122014
◗ FIGURE 29.2
Median ratio of cash to
assets for U.S. nonfinan-
cial firms, 1980–2014.
Source: Compustat

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