Corporate liquidity management

The global financial crisis drew fresh attention to way firms manage liquidity, as credit markets dried up and internal savings became key to corporate survival. Liquidity management is an old topic; it has been discussed at least since John Maynard Keynes' examination in 1930s. It attracts much attention today, as large companies world-wide have amassed some $4 trillion in idle on their balance sheets. Figure 1 depicts S&P 500 firms' holdings of cash and liquid securities over last 20 years. The holdings of liquid assets are highest both in absolute values as well as a fraction of total corporate assets since at least WWII. (1) Apple Inc., alone, has recently reported holding nearly $180 billion in cash, enough to acquire combined equity and debt values of its industry rivals, and comparable to GDP of Portugal or Greece. Academic work on corporate liquidity took oft around 2000. The notion of corporate liquidity management has since evolved to encompass not only how firms administer their cash balances, but how they deal with credit lines, manage their debt capacity, and use derivatives for hedging. Central to this research is idea that managers use liquidity as a way to maintain financial flexibility if their firms should face difficulties securing funds in capital markets. In corporate world, financial flexibility can be key to sustaining firms' real-side operations at close to optimal levels. In that regard, broad conclusion is that cash remains king, at least for certain groups of firms. Debt capacity does not provide same degree of downside protection as cash, and derivative instruments can only help with a limited set of risks that are traded in market. While credit lines are good all-around substitutes for cash, firms may still prefer cash when their liquidity risk is systemic in nature, and thus hard for banks to insure. The global financial crisis taught us that, in bad times, banks are unable to insure against surges in corporate liquidity needs, as banks themselves may experience liquidity shortages too. Is There an Optimal Level of Cash? There is a general fascination with level of cash companies carry on their balance sheets. Various figures are discussed in media, among academics, practitioners, and even in Federal Reserve Board meetings. But this focus on--or search for--the optimal corporate cash level may be misplaced. In practice, literature's focus on cash has been driven by lack of data on alternative mechanisms of liquidity provision such as credit lines and derivatives-based hedging. Now, however, it is becoming possible to incorporate data associated with these other mechanisms into analysis of corporate liquidity. For example, recent studies have documented that existence of undrawn credit lines can add substantially to a firm's liquidity. Firms that hold undrawn credit lines also hold some cash, but firms without access to credit lines hold significantly more (2) Credit line facilities, too, add up to trillions of dollars nowadays and message one should take from this is that cash balances are a by-product of tradeoffs that firms face in dealing with their liquidity needs. There should be less focus on observed cash balances per se, and more awareness that cash management is just one piece of a multi-faceted process. In joint work, Heitor Almeida, Michael Weisbach, and I proposed looking beyond corporate cash levels to examine how firms handle their marginal savings decisions. (3) We look at why firms may choose to save funds from operating cash flows, and which firms are likely to do so. We show that firms can engage in very active liquidity management processes independent of level of cash shown on their balance sheets. We model and discuss a concept that we dub the cash flow sensitivity of cash. In essence, we isolate fraction of incremental cash flows that firms retain as additional cash in each period. …