In 2010, 2011, and earlier in 2012, many large corporations in the United States built up their cash positions to extraordinarily high levels. I have often written about this during the period.
The rationale behind this buildup in cash was the argument that these corporations were increasing their war chest to go on an acquisition binge as the growth in the United States and world economies began to accelerate.
The companies increasing their cash hordes were well off financially and were also able to issue debt at ridiculously low interest rates. They believed that they could take advantage of weaker and less financially sound organizations as the economic growth began to pick up speed. This would place the acquirers in an even stronger competitive position as markets really began to strengthen.
The merger and acquisition boom never took place.
The basic reason given for the lack of M&A activity was the uncertainty surrounding the political situation in the United States and the uncertainty about the strength of the economic recovery. In terms of the political situation, the lack of leadership in Washington, D. C. clouded the future of economic and monetary policy. And, the economy experienced only tepid growth accompanied with the fear that there might be the second act of a double-dip recession in the near future.
Given all this uncertainty, the large corporations holding all the cash were certainly not going to make any large bets on the future. Making large commitments to acquire other corporations was considered to be too risky so corporate managements erred on the side of caution. Furthermore, it was felt that if nothing developed in the future the cash could always be used to pay dividends to shareholders or could be used to buyback stock.
There seemed to be very little consideration amongst these managements to invest in physical capital…plant and equipment.
And, the lack of investment expenditures on plant and equipment contributed to the slow pace of economic growth.
Now, there seems to be a change in the air.
However, the change does not seem to be in favor of the purchase of plant and equipment.
The change seems to be in the direction of these corporations paying cash dividends or buying back company stock.
We now see headlines like "Record Special Payouts from US Companies" and "US Fiscal Cliff Drives Special Dividends". That is, concerns over the changes in tax rates being talked about in current budget discussions are driving firms to using their cash hordes to increase regular dividends or pay special dividends.
So far, 103 US companies have announced that they will pay a special dividend before the end of this year. This is a record number, far above the previous record of 74, paid in 2010.
In addition, possible changes in the tax laws have created the incentive for corporations to buy back their stock. In the New York Times we read that "companies are likely to shift more money to buybacks after this year because taxes on those gains are expected to grow less than a proposed tax increase on dividends."
Share buybacks hit a near-term low in 2009, a time when companies would have benefited the most from buying back their own shares. Cash was being held for possible mergers and acquisitions. The pickup in buybacks in 2010 and 2011 was modest.
"So far this year, companies have announced share buybacks worth over $220 billion, more than were announced in all of 2011."
Although the present time is not optimal for stock buybacks, they are expected to increase because of the changing tax scene.
And, these corporations are not going to use their cash to invest in plant and equipment.
Gregory V. Milano, chief executive of Fortuna Advisors is "not happy about this," according to the Times article. "When you buy back stock with money you could have re-invested, you not only deliver worse returns, you wind up employing less people."
What does this tell us about the economic environment?
Well, for the last three years or so, large corporations held onto large amounts of cash because they were looking to acquire other companies as the economic recovery progressed. They were not looking to use the cash to pay dividends or buy back their stock. And, they were not looking to use their cash to invest in new plant and equipment.
Now, these large corporations are apparently going to use their cash to pay out dividends or to buy back their stock. They are not as confident that the economic recovery will be strong enough to justify the purchase of other companies in the number they believed would be the case earlier. They have four years experience with the political leaders now in place. And, they are not looking to use their cash to invest in new plant and equipment.
Corporate confidence in the economic future is not great! Even with interest rates as low as they are and even with the economy growing modestly, these corporations are not willing to bet on the future.
This conclusion, in itself, is not a great confidence builder.