One of the great constants in this otherwise inconstant environment is the strength of corporate finances. Financial excesses and the need to deleverage concern governments and households, but not companies. The corporate sector actually came out of the 2008-2009 financial crisis and recession with its finances in good order and has only strengthened them since. The question now is how and when companies will deploy these impressive financial resources on capital spending, hiring and especially on the mergers and acquisitions (M&A) that typically proceed from strong corporate finances?
Huge cash holdings constitute the most impressive aspect of this financial strength. At the close of 2011, the most recent period for which complete data are available, cash on non-financial corporate balance sheets had risen to over $1.9 trillion, a jump of almost 60% from the dark days of 2008 and up more than 50% from the last cyclical peak in 2007. Cash and cash equivalents have risen so that today they constitute almost 13% of all corporate financial assets, up from 9.4% in 2008 and 9.1% at the cyclical peak in 2007. They amount to some 14% of all corporate liabilities, up from 9.2% in 2008 and 9.7% in 2007, and almost 12% of corporate net worth, up from 8.9% in 2008 and 8% in 2007.
While powerful cash flows permitted such accumulations, it is the high and persistent level of uncertainty that has kept the funds in cash instead of flowing into other corporate uses. Speaking volumes about this motivation is the fact that the bulk of the cash sits not in time or savings deposits, money market shares or commercial paper, but in checkable deposits. These have grown remarkably, over 1500% in fact, since 2008. The high level of uncertainty this behavior reflects is hardly surprising either, on at least four counts:
The legacy of the 2008-2009 financial crisis, still fresh in managers’ collective memories, has kept companies sensitized to how suddenly economic and financial conditions can change and consequently how valuable ready, liquid assets can be. Moreover, because bank credit standards tightened during the crisis and by and large have remained tight since, companies have lost the conviction that they can borrow should the need arise. It does not help in this regard that many banks during the crisis withheld formerly well-established corporate lines of credit, an act that has left in its wake a conviction among corporations that they ought to rely more on self-financing. The sovereign debt problems in Europe, threatening a rerun of 2008-2009, have only redoubled this conviction.
Obamacare has contributed, too. Whether a good idea or a bad one, the huge changes built into this complex law impose tremendous uncertainty on corporate decision making, particularly about hiring. The natural response is to hold off on major corporate decisions, and the enlarged cash holdings are an obvious financial consequence of that posture.
The Dodd-Frank financial reform has had its own separate influence. Although this huge piece of legislation mainly affects financial corporations, it does nonetheless create uncertainty among all companies about both the availability and cost of future financing. In this regard, Dodd-Frank has surely had an effect similar to the liquidity problems of 2008-2009, even though it was ostensibly designed to correct them, and adds to management convictions that they can no longer rely on credit lines from financial institutions and therefore need to do more to cover their short-term cash needs for themselves.
If these matters did not weigh heavily enough, corporations must also cope with the uncertainties surrounding the federal budget debate. Without knowing the nature and size of future federal spending or taxes or even the federal government’s prospective borrowing needs, it is difficult for managers to gain any sense of the future and consequently deploy their resources.
But for all this, there are tentative signs that corporations are beginning to use some small portion of their cash accumulation. Though hiring has remained sub-par by past cyclical standards, hardly a surprise in such an uncertain environment, it has picked up some in recent months. Corporations have also increased capital spending, raising such outlays by almost 8% over the course of 2011, hardly a boom but certainly faster than sales have risen and a use for some of these surplus funds. At the same time, they have shown a modest willingness to extend themselves by accepting a rise in their trade and tax payables. Together, these have risen more than 13% during the past year, faster than sales and even cash balances.
Still, it will take time before a return of confidence can move matters beyond the recent, tentative expressions. Cash and the lack of confidence it reflects remain high. There is, however, a tremendous potential for dramatic expansion in corporate spending, hiring, and M&A activity given even a modest improvement in confidence. Especially since equity market valuations these days make it cheaper to buy than to build, the potential for M&A, with its always immediate market impact, looks particularly powerful.