Understanding Precautionary Cash at Home and Abroad

Michael Faulkender, Kristine W. Hankins, Mitchell A Petersen

Research output: Working paper

Abstract

In the presence of market frictions, it is optimal for firms to stockpile cash to fund investment projects which may arise in the future. Prior work has documented that firm’s precautionary savings motives predict variation in the size of firm’s cash stockpile. The dramatic run up in cash stockpiles raises the question of why these precautionary motives have become stronger. In the presence of repatriation taxes, foreign and domestic cash are imperfect substitutes. We show that although precautionary motives explain variation in the level of cash held domestically, they provide little explanatory power for the level of foreign cash. Multinational firm’s foreign cash balances are instead explained by low foreign tax rates and the ability to transfer profits within the firm through related party sales. The firms with the greatest incentive and ability to transfer income to low tax jurisdictions do, and this results in stockpiles of cash trapped in foreign subsidiaries.
Original languageEnglish (US)
Number of pages32
StatePublished - Dec 2015

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