Cash savings are the single greatest use of share issuance cash flows among U.S. firms, which on average save $0.49 per $1 of share issuance; as a comparison, these firms save $0.03 per $1 of debt issuance, and $0.29 per $1 of cash flows from operations. Moreover, the share issuance savings rate has more than doubled over the past thirty-five years, from $0.23 per $1 in 1971, to $0.62 per $1 in 2005. Hence, when firms issue shares today, they tend to save the majority of the proceeds. In this paper I try to explain why firms save such a large portion of their share issuance proceeds as cash; doing so should deepen our understandings of why firms issue shares, and whether the U.S. equity market is an efficient allocator of financial resources.
I consider corporate governance, market timing, and precautionary motives as potential explanations for the share issuance-cash relation. The results do not support corporate governance or market timing; however many of the results are consistent with precautionary cash savings.
The precautionary motive for cash holdings contends that firms with volatile cash flows from operations and with valuable investment opportunities should accumulate large precautionary cash balances. Firms with volatile cash flows are more likely to face a cash shortfall, and such shortfalls are more costly for firms with valuable investment opportunities. Papers by Opler, Pinkowitz, Stulz, and Williamson (1999), Haushalter, Klas, and Maxwell (2007), and Bates, Kahle, and Stulz (2008) show that firms with high precautionary motives hold more cash, suggesting that firms maintain precautionary cash targets. I use R&D spending and fitted cash values from the cash-holdings model of Opler et al. as proxies for precautionary motives.
The results suggest that savings of share issuance proceeds as cash are the result of efforts to maintain precautionary cash levels. The average high R&D share issuer begins the year with a cash-to assets ratio of 0.27, while the average low R&D issuer begins the year with a cash-to-assets ratio of 0.13. If both groups of firms have similar growth in non-cash assets, then the high R&D firms will have to save more cash to maintain their cash ratios. The average high R&D share issuer saves $0.60 per $1 of share issuance, while the average low R&D issuer saves $0.35 per $1. The average high R&D issuer ends the year with a cash-to-assets ratio of 0.28, while the average low R&D issuer ends the year with a cash-to-assets ratio of 0.13; hence both groups of firms save enough to maintain their cash-to-assets ratios, suggesting that firms use share issuance cash flows to maintain cash balances.
The increase in the savings of share issuance cash flows over time can also be explained by increasing precautionary motives. Bates, Kahle, and Stulz (2008) show that cash balances have increased over the last 25 years, and they show that precautionary motives have also increased over this period, mirroring the increase in the savings rate of share issuance cash flows.
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Share Issuance and Cash Savings
