A widespread aversion to risks spawned by corporate scandals and the Sarbanes-Oxley Act has helped push corporations to shore up whopping cash positions on their balance sheets, according to Federal Reserve Governor Kevin Warsh.
In a speech Tuesday at the American Enterprise
Institute, Warsh observed that “a striking
feature” of the current economic expansion has been
the historic highs in cash and short-term
securities holdings that the corporate sector has accumulated
The increase is even more pronounced when cash is
measured against investment, which he defined as
the sum of capital spending and research-and-development-spending during the preceding 12 months.
The ratio of cash to investment has averaged about 60 percent during the past few decades, according to Warsh. Generally, that percentage is higher in recessionary periods, reflecting a strong precautionary savings motive by firms that face expensive outside financing.
But the ratio soared to more than 150 percent by year-end 2004, as investment fell far short of cash flow from operations and net financing. “This juxtaposition is unusual when the economy is expanding,” he added.
Further, aggregate cash holdings stayed high through much of last year, even as the economy “continued to advance smartly,” according to Warsh. One explanations advanced for the unusual rise is the growing presence of U.S. multinational subsidiaries in countries with lower corporate tax rates and the recent accumulation of earnings retained by the foreign subsidiaries, he noted.
A second possible factor is the renewed stress investors may be placing on balance-sheet liquidity, particularly in the aftermath of commercial paper defaults that occurred at the end of the previous expansion.
Yet another theory, however, is that the conditions created by the recent corporate scandals and the regulatory response to those events has contributed to a more cautious attitude toward risk taking. That caution may include restraint in capital spending, according to the Fed Governor.
Complying with Sarbox has diverted funds “and,
probably even more importantly, some of the attention
of chief executive officers and boards of directors
from capital spending and R&D plans.”
Warsh noted that every meeting that board members and executives spend on compliance is time not spent on big strategic questions.
To be sure, firms are benefiting to some degree from Sarbanes-Oxley he said. Nevertheless, he added: “Based on the evidence available to date, I believe that the uncertainty resulting from the regulatory and legal environment has had meaningful economic implications for business investment and cash holdings.”