Cashing Out

By Justin Walker

Do corporations keep too much cash on hand? It may seem like an odd question, but corporate cash retention has become a hot topic in recent years, Hwanki Brian Kim, assistant professor of Finance at the Hankamer School of Business, said.

Kim’s research, “Do Corporations Retain Too Much Cash? Evidence from a Natural Experiment,” published in The Review of Financial Studies, explores the question within the context of governmental regulation.

“The overall cash holding by corporations has gone up a lot,” he said. “Since the financial crisis of 2008, firms have been increasing their cash holding by more than two-thirds, which is huge. Some policymakers thought it was a corporate attempt at delaying economic growth. That’s the debate going on.”

The study, co-authored by Woojin Kim of Seoul National University and Mathias Kronlund of Tulane University, looked at the market reaction to a South Korean reform that introduced a tax on earnings retained as cash, Kim said. The new policy forced corporations to invest, payout or increase wages using the extra cash on hand.

Through the natural experiment, the researchers identified the treatment group—firms subject to the tax—and the control group, or those not subject to the tax. Firms in the treatment group were taxed 10 percent on cash savings over a certain threshold, Kim said. To avoid the tax, the firms were forced to spend the money, either through investments or increased wages.

Kim and his fellow researchers found that the market believed firms were saving too much cash, he said.

“Government tax on this cash saving was deemed to be a positive thing for these companies,” Kim said.

For firms affected by the reform, how they spent their cash savings directly impacted their stock prices, he said. The study found that firms that increased payouts typically experienced higher valuations, while those that allocated more to investments saw lower valuations.

“Some forced spending out of cash savings could be helpful for some firms,” Kim said. “But for firms with poor corporate governance, it could make things worse.”

Kim believes this tax reform approach is not a silver bullet and policymakers should consider governance structure if making this type of policy.

This research opens the door to studying other tax reform policies, Kim said. His future studies will examine recent U.S. tax reforms introduced by the Biden administration.

“We are interested in how these kinds of policies play out in U.S. corporate settings and how they affect firms in the U.S.,” he said.