Posted by Jarrad Harford, University of Washington; and Cong Wang, China Europe International Business School, on
Thursday, February 9, 2017
Jarrad Harford is the Paul Pigott-PACCAR Professor of Finance at Foster School of Business, University of Washington; and Cong Wang is Professor of Finance at China Europe International Business School. This post is based on a recent article forthcoming at the Review of Financial Studies by Professor Harford, Professor Wang, and Kuo Zhang, Assistant Professor of Finance at School of Economics & WISE, Xiamen University.
U.S. multinational corporations park trillions of dollars of cash in low-tax jurisdictions to avoid the taxes associated with repatriating their foreign earnings. Company filings to the SEC for fiscal year 2016 show that some of the largest multinational companies, such as Apple and Microsoft, held over 90% of their cash reserves abroad. While keeping foreign earnings outside the U.S. can bring tax savings to shareholders, it may also hurt firm value through financing frictions and potential agency problems arising from the use of foreign cash. In our new article, Foreign Cash: Taxes, Internal Capital Markets, and Agency Problems, we investigate the shareholder value implications of parking large amounts of cash abroad.
We manually collect the amounts of foreign cash reserves for a sample of firms in the S&P 1500 index that disclose such information in their 10-K filings. Using a value-of-cash model, we find that the marginal value of a firm’s cash declines as the proportion of its total cash that is held abroad (foreign cash ratio) increases. This result suggests that investors place a discount on firms’ cash that is trapped overseas. We also examine the economic magnitude of this discount and find that a one standard deviation (0.29) increase in the foreign cash ratio is associated with a reduction of the marginal value of cash by $0.31. This large economic impact goes beyond the repatriation tax cost a firm would incur when bringing its foreign cash back to the U.S. To provide a more complete picture of the sources of the foreign cash discount, we next investigate the potential real consequences of stockpiling cash abroad.
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