Comparing the Cash Policies of Public and Private Firms
Executive Summary — Industrial firms listed on stock markets in the United States held $1.5 trillion in cash at the end of 2011. Many commentators and policymakers observed that this so-called "dead money" might be one reason behind the sluggish performance of the United States and other developed economies since the Great Recession. But evidence on such cash-hoarding behavior is limited to listed (or 'public') firms, which account for a relatively small part of the US economy. Do private firms also hold large cash balances? Using a rich panel of over 200,000 non-SEC-filing private US firms, the author finds that the average public firm holds twice as much cash as the average large private firm over the 2002-2011 period. Results are most consistent with the hypothesis that differences in the extent to which public and private firms engage in market timing are a key driver of public firms' higher demand for cash, as the risk of misvaluation induces public firms to raise capital and accumulate precautionary cash reserves when they perceive their equity to be overvalued. Consistent with this hypothesis, the author finds that the cash difference between public and private firms is larger in industries with a higher prevalence of misvaluation shocks. In addition, public firms in these industries tend to save a larger fraction of their equity issuance proceeds than private firms, particularly in times when they have reasons to believe that their equity is overvalued. Key concepts include:
- Private firms are a large and underexplored part of the US economy. This paper underscores the limitations of extrapolating what we know about public firms to private firms.
- The much-debated cash-hoarding behavior of public firms has not been followed by their private counterparts.
- Public firms' greater access to capital explains about one-quarter of the cash difference between public and private firms. The remainder can be explained by differences in the extent to which public and private firms engage in market timing in response to misvaluation shocks.
- Unlike their public counterparts, private firms do not hold large precautionary cash reserves. This is surprising, particularly in light of the fact that, among public firms, those that are small and have worse access to capital (that is, those that look the most like private firms) hold the most precautionary cash.
I document that public U.S. firms hold twice as much cash as large privately held firms, a surprising finding that is robust to three alternative identification strategies: matching, within-firm variation, and instrumental variable. Public firms' greater access to capital accounts for about one-quarter of the difference. The remainder can be explained by differences in the extent to which public and private firms engage in market timing in response to misvaluation shocks. I show that the risk of misvaluation induces public firms to raise capital and accumulate cash reserves when they perceive their equity to be overvalued, resulting in greater demand for precautionary cash holdings.