Are Firms Hoarding Cash Post-Pandemic?

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Business cash holdings have soared since the onset of the COVID-19 pandemic amid surging fiscal spending, a growing Federal Reserve balance sheet, and rising economic uncertainty. As a result, cash holdings relative to GDP remain substantially higher than pre-pandemic levels for both large corporate firms (Chart 1, blue line) and smaller, non-corporate firms (purple line). Historically high aggregate cash balances, combined with the unprecedented structural changes wrought by COVID-19, have fed speculation that firms are now “hoarding” cash, which can be defined as retaining cash in excess of what is needed to cover liquidity needs or take advantage of investment opportunities.

Chart 1: Business cash holdings have increased since the pandemic

One way to assess whether firms have been hoarding cash since the pandemic is to examine their motives for holding it. Typically, firms are thought to hold cash for either precautionary or investment purposes. Indeed, cash provides liquidity during economic downturns when earnings may be low and external debt markets inaccessible. Cash also allows firms to avoid costly external financing when pursuing investment opportunities. Cash hoarding, however, can have negative effects on firms and the economy more widely. Given that cash generates low relative returns due to its lack of risk, excess cash balances reduce firm profitability. Moreover, management at firms with large cash balances may be incentivized to make risky investments or to spend frivolously, both of which can threaten a firm’s long-term viability and reduce the productive capacity of the economy (Jensen 1987).^_

To assess whether firms are indeed hoarding cash, we investigate whether firms’ reasons for holding cash have changed in recent years by examining pre- and post-pandemic correlations between traditional determinants of cash holdings and the cash ratio—the ratio of firms’ cash to assets.^_ Specifically, we examine the degree to which firms are holding cash to position themselves for investment opportunities, to store sudden gains from profitability, to compensate for a lack of collateralizable tangible capital, or to mitigate risk (a precautionary motive).

Chart 2 shows that investment opportunities—measured by the ratio of a firm’s market value to its book assets, or Tobin’s Q—explain the largest portion of the cash ratio in both the pre- and post-pandemic periods. In our sample, a one-standard-deviation increase in investment opportunities increases the average firm’s cash ratio by nearly 5 percentage points, slightly less than the estimated 7 percentage point increase in the pre-pandemic period.

Chart 2: Firms’ cash holdings increase with profitability, investment opportunities, and riskiness

Profitability, measured as return on assets (ROA) over the previous 12 months, ranks a close second in explaining cash holdings. The effect of higher profitability on cash holdings appears to be little changed in the pre- and post-pandemic periods: a one-standard-deviation increase in ROA increases the cash ratio by about 3 to 4 percentage points, on average.

Precautionary motives play a smaller role in explaining cash holdings in both the pre- and post-pandemic periods. Although firm risk does appear to influence cash holdings, the effect is smaller than that for non-precautionary motives and does not differ between the pre- and post-pandemic periods. Firms have historically held cash balances as a precaution against tapping costly (or inaccessible) external financing, or to smooth income volatility. We represent such precautionary motives using the volatility of a firm’s stock return and the volatility of a firm’s cash flow, defined as the normalized variance in operating cash flow. Both measures raise cash holdings in the pre- and post-pandemic periods to a similar degree across time, with return volatility exerting a larger force on cash holdings relative to cash flow volatility.

In addition, intangible asset shares, a corollary to precautionary capital holdings for specific business models, do not appear to explain firms’ cash holdings. Corporate finance theory argues that firms with more intangible capital have limited access to debt markets because they have less pledgeable collateral (Falato and others 2017). However, we find that this theory explains little of firm cash ratios after controlling for firm size and industry, particularly in the post-pandemic period. Prior to the pandemic, firms with large intangible capital shares had about 1 percentage point higher cash ratios than firms in the same broad industry with less intangible capital. Post-pandemic, however, this effect is statistically indistinguishable from zero. Overall, Chart 2 shows that firms do not appear to be more motivated by precaution to hold cash than they were before the pandemic.

Importantly, the large aggregate cash balances seen recently have not been distributed uniformly across firms. Instead, profit differentials and disparate investment opportunities are encouraging the distribution of cash to normalize. Chart 3 shows that cash concentrations across publicly traded firms are slowly returning to pre-pandemic levels. At the onset of the pandemic, the “dash-for-cash” and disbursement of federal dollars widely distributed money across firms, and cash concentration declined. However, cash concentration has increased more recently. This increased cash concentration suggests, in concert with our results, that cash is migrating back to firms best positioned to deploy it.

Chart 3: Cash concentration has normalized after initially declining during the pandemic

Overall, increased cash concentration, together with evidence that investment opportunities are driving firms’ current cash holdings, suggests that firms are not “hoarding” cash. Rather, our results suggest that cash is accruing to the firms most likely to invest prudently or well-managed enough to operate profitably.