How They Spend It:

A study of corporate cash levels

and spending behaviour

M&A Research Centre MARC

www.cass.city.ac.uk/marc

MARC Mergers & Acquisitions Research Centre

MARC is the Mergers and Acquisitions Research Centre at Cass Business School, City University
London the first research centre at a major business school to pursue focussed leading-edge
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MARC blends the expertise of M&A accountants, bankers, lawyers, consultants and other key
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Corporations, regulators, professional services firms, exchanges and universities use MARC for swift
access to research and practical ideas. From deal origination to closing, from financing to integration,
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the wide spectrum of mergers, acquisitions and corporate restructurings.
The Centre is proud to have its senior sponsors, Credit Suisse and Ernst & Young, and
sponsor, Mergermarket, as research partners.

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Overview

ash is king. Now more than ever is

this saying true. Companies which
were listed on the London Stock
Exchange at any point in time during the last
15 years are currently holding record levels of
cash reserves, on average 40% of net assets
in 2010, translating to an aggregate amount of
$643bn. Given the recent turmoil in the
European financial markets, the retention and,
therefore, the immediate availability of cash
reserves are functioning as a safety net. But is
the cash at companies disposal in excess of
the so-called sufficient cash level? How do
companies tend to spend this excess cash,
and which spending strategy has the potential
to generate the highest returns for
shareholders?
v

The M&A Research Centre (MARC) at Cass

Business School has, in collaboration with its
senior sponsors, Credit Suisse and Ernst &
Young, performed an in-depth analysis of a)
the factors which determine the cash levels
which companies need to keep at hand, b) the
spending habits of corporates and c) the cash
disposal strategies which are most successful.
Highlights of this report:
The cash reserves at companies
disposal are at an all-time high. The
average cash to net asset ratio for the
study sample was equal to 40% in 2010,
compared to a long-term average of
26%. The average ratio of excess cash
to net assets (as defined by our model)
reached 30%, compared to a long-term
average of 10%. These figures translate
into actual and excess cash levels of $643bn
and $450bn respectively for 2010.
The most cash-rich industries, in terms of their
cash to net assets ratio, are Technology
(49%), Healthcare (47%), Consumer Services
(44%) and Industrials (34%), but the factors
which influence the sufficiency of the cash
reserves at firms disposal can differ
substantially across industries. Nevertheless,

there are four factors which appear to

determine cash levels for most companies,
irrespective of their industry. These are the
current net cash flow, managements
expectation of the degree to which cash flow in
subsequent periods will meet the need for
planned investments, as well as the size and
liquidity of a companys business.
The analysis of the timing of firms cash
disposal activities reveals that the spending
type which adjusts most rapidly to
changes in excess cash is increase in
dividends. In addition, companies tend
to prioritise spending for the purpose of
investments in the form of acquisitions
or organic growth (which occur in the
first or second year following a period
with excess cash) as compared to other
forms of spending, such as buybacks
(which tend to occur at a later stage, i.e. in the
second or third year following a period with
positive excess cash).
Corporates which choose to keep the
excess cash reserves at hand for a
period longer than one year are
penalised by the market. The analysis
shows that this strategy is the worst way of
managing the additional liquid funds at firms
disposal, resulting in an average risk-and
index-adjusted underperformance of -15% in
the long term.
Two of the spending strategies clearly
outperform
the
others,
namely
acquisitions
and
share
buybacks.
Buybacks
reap
benefits
earlier
(generating average returns amounting
to 7% after 24 months). However, the
strategy of spending on M&A generates
even higher returns - equal to 11% realised in the third year after the
implementation of the strategy. When
adjusted for risk, however, the two
strategies are almost at par, generating
15% and 14% respectively in the third
year following implementation.
1

Cass Business School

February 2012

Corporate Cash Holdings

orporates are holding record levels of

cash reserves. Since the mid 90s,
companies which were listed on the
London Stock Exchange at any point in
time during the last 15 years have
maintained cash levels of around 26% of
net
assets.
This
level
increased
substantially during 2009 and 2010, with
the average cash reserves to net asset ratio
equal to the all-time record levels of 34%
and 40% respectively. The aggregate cash
holdings of the sample companies
amounted to $574bn in 2009 and $643bn in
2010 as compared to a long-term annual
aggregate average of $423bn. However, it is
important to note that not all of these cash
reserves represent extra liquidity. Financial
theory states that each firm needs to maintain
a specific level of cash in order to perform its
ordinary business activities and to avoid
financial difficulties or bankruptcy. 1 This level
will henceforth be referred to as the sufficient
level of cash. The difference between the
actual and sufficient cash reserves constitutes
the so-called excess cash, i.e. the proportion
of cash which the company can freely choose
how and when to utilise. But is it possible to
measure the size of the sufficient cash
reserves which companies should hold and
thereby determine the proportion which is in
excess?
To address these questions, we first need to
identify the factors which affect the level of
cash reserves that companies need to keep in
order to perform their ordinary business
activities and to avoid financial difficulties or
bankruptcy, i.e. the sufficient cash reserves.
These factors can be broadly classified as
macro-economic and company-specific. The
macro-economic factors are related to the
level of economic activity, the availability of
financial capital, i.e. financial liquidity, as well

See e.g., Opler et al. (1999) The determinants

and implications of corporate cash holdings in the
Journal of Financial Economics.

as the overall market sentiment. The

company-specific factors relate to the effect of
current cash flows on company cash reserves,
managements expectation of the likelihood
that the companys future inflow of cash will be
either sufficient or insufficient to meet future
planned investment, the growth opportunities
faced by the company, the riskiness of its
business, the ease with which it can access
external
finance,
its
working
capital
requirements, cost of capital and level of
leverage. In order to identify the most
important
determinants
of
companies
sufficient cash levels, we modelled firms
current cash reserves to variables which proxy
for the aforementioned macro-economic and
company-specific factors over the period 1996
to 2010. Given that cash levels can vary
substantially across industries, we performed
the analysis separately for the eight industries
included in our study.2 We used the industryspecific cash models to estimate the sufficient
cash level for each firm. The difference
between the actual and sufficient cash
represents the excess cash at a companys
disposal.3
Exhibit 1 presents the historical evolution of
the sample companies average actual,
sufficient and excess cash (as determined by
our model) reserves between 1996 and 2010.
Companies were sitting on approximately
$450bn of excess cash in 2010. The ratio of
excess cash to net assets reached an alltime high of 30% in 2010 as compared to a
long-term annual average of 10%.

This follows the methodology adopted by Harford

(1999) in Corporate Cash Reserves and
Acquisitions in The Journal of Finance.

Excess cash can be either negative or positive

depending on whether a given company needs to
increase its cash reserves in order to do business
as usual or whether it is in possession of more than
what is necessary.

Cass Business School

February 2012

Exhibit 1: The evolution of average actual, sufficient and excess cash between 2006 and 2010

FTSE All-Share

Sufficient

Actual

40%

Excess

40%

30%

30%
20%

20%
10%

10%

0%

0%

-10%

-10%

-20%
-20%

-30%

Excess cash to net assets and

change in FTSE All-Share index

Actual and sufficient cash to net

assets

50%

-30%

-40%
1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Actual, sufficient and excess

cash to net assets

Exhibit 2: Industry breakdown of sufficient and excess cash for 2009 and 2010

60%

Healthcare
50%

Consumer
Services

Industrials

40%

Technology
Telecom

Consumer
Goods

Basic Materials

30%

Oil & Gas

20%
10%
0%
2009

2010

2009

2010

2009

2010

2009

Sufficient Cash

2010

2009
Excess Cash

2010

2009
Actual Cash

2010

2009

2010

2009

2010

Exhibit 1 shows the evolution of annual average sufficient, excess and actual cash (all deflated by net assets) over the sample period. Excess cash is measured on the right axis, whereas
actual and sufficient cash reserves as well as the percentage yearly change in FTSE All-Share Index are measured on the left axis. The level of sufficient and excess cash must add up to the
actual cash reserves at a given companys disposal according to our methodology. Exhibit 2 shows the breakdown of average actual cash levels into sufficient and excess cash per industry
for 2009 and 2010. Please refer to the Data and Methodology section of this report for further details on the sufficient and excess cash estimation procedure.

Cass Business School

3
February 2012

Exhibit 1 also reveals that the level of the

sample companies excess cash and the FTSE
All-Share index are inversely related, i.e.
companies tend to accumulate excess cash
reserves in periods of economic downturn.
Actual and excess cash reserves steadily
increased over the sample period. Conversely,
sufficient cash decreased over the same
period, particularly after 2004. There are two
explanations for the long-term trends which
sufficient and excess cash display over our
sample period. First, companies appear to
have become increasingly more efficient users
of the external capital market, which has
enabled them to maintain their ordinary
business activities without the need to
accumulate large cash reserves. This
argument is supported by a decrease in the
average cost of capital of the sample
companies by 29% between 2002 and 2007.
We report growth figures before the financial
crisis as it is expected that with the substantial
increase in market risk during the period 2008
to 2010, the cost of capital also increased
during the latter period. According to our
sample data, the average cost of capital
increased by 15% during the crisis period.
Secondly, companies have improved their
ability to manage their cash conversion cycle,
meaning that they are more confident that
future cash inflows will suffice to meet the
planned outflows of cash which are necessary
in order to maintain ordinary business
activities. We support this argument with the
observation that the average net working
capital of the sample companies decreased by
32% between 2002 and 2007. It should be
noted that the average net working capital
holdings increased by 6% during the financial
crisis period between 2008 and 2010.
Despite the short-term reversal of these
trends in the change in cost of capital and
net working capital between 2008 and 2010,
the level of sufficient cash that companies
needed in order to perform ordinary
business activities continued to decrease
over the same period. We note that the
level of sufficient cash reserves that
companies hold moves in line with
economic growth, as companies need more

cash in order to expand. As UK economic

activity slowed down substantially between
2008 and 2010, it is expected that
companies needed less cash in order to
maintain their businesses over the same
period. The UK GDP annual growth rate
was approximately 52% lower than that
reported for 2007.4
Exhibit 2 presents a breakdown of actual
reserves into sufficient and excess cash at the
industry level for 2009 and 2010. The exhibit
shows that the most cash-rich industries, in
terms of their cash to net assets ratio, are
Technology (49%), Healthcare (47%),
Consumer Services (44%) and Industrials
(34%). These results confirm the findings of
previous studies which analyse company cash
reserves.5 Exhibit 2 also reveals that, in many
cases, the average sufficient cash reserves
are lower than the excess cash reserves at
companies disposal, which is in accordance
with our findings for the overall sample. The
discrepancy between excess and sufficient
cash reserves, i.e. the amount by which
excess cash reserves exceed sufficient
cash, is most pronounced in the Healthcare
(where this gap amounts to +26pp),
Technology (+25pp), Consumer Goods
(+17pp) and Oil & Gas (+12pp) sectors.
Despite the differences in the determinants of
cash reserves between the sample industries,
the results from the industry-specific cash
models indicate that there are four factors
which affect most companies, irrespective
of their industry, namely current net cash
flow; managements expectation of the
degree to which cash flows in subsequent
periods will meet the need for planned
investments; the liquidity of the business,
as identified by the ratio of net working
capital to net assets; and the size of the
firms business.

This figure is based on data provided by Eurostat.

See e.g., Harford (1999) in Corporate Cash

Reserves and Acquisitions in The Journal of
Finance.
4

Cass Business School

February 2012

Corporates Spending Patterns

ompanies are faced with various
options when it comes to how and
when to utilise the excess cash at their
disposal. The different methods of spending
excess cash can be divided into five so-called
spending strategies, namely: 1) invest the
funds internally in the form of capital
expenditure; 2) invest the funds externally in
the form of acquisitions; 3) increase cash
dividends or introduce special dividends; 4)
repurchase shares; and 5) decrease the level
of long-term debt. In addition, companies can
choose the timing of excess cash disposition,
i.e. they can opt for immediate cash utilisation
or delay spending until a feasible opportunity
occurs. Is there a given pecking order that
companies attach to the different spending
options with which they are faced?

there is a slight delay in the adjustment of

spending on M&A and capital expenditure
to the changes in excess cash which
happen over the two-year period following
the year when the company reported
excess cash. The results also demonstrate
that the change in spending on share
repurchases takes effect over a three-year
period, i.e. the delay in the adjustment of
buyback spending is higher relative to the
delay observed for the spending strategies
of acquisition and capital expenditure.
There is no discernible speed of adjustment of
the amount used in order to reduce long-term
debt, i.e. companies which have excess cash
will use some of it in order to deleverage,
however the timing of this spending strategy is
not a priority.

In order to answer this question, we adopted a

regression analysis to determine whether
excess cash can explain a companys
spending strategy. Thus, in our models, the
amount spent on each strategy (i.e. an
increase in capital expenditure, acquisitions,
an increase in dividend, share repurchase or a
reduction in long-term debt) is explained by the
level of excess cash together with a number of
control factors (i.e. other variables which
affect this particular type of spending). 6 The
analysis reveals that increasing dividends
is the spending type which adjusts most
rapidly to changes in excess cash, i.e. the
change in dividend payment responds
immediately (next year) to the level of
excess cash in a given year. In contrast,

Overall, the analysis reveals that the spending

method which appears to take place sooner
than the others is increasing cash dividends.
This is followed by acquisitions and increases
in capital expenditure, with the spending type
with the slowest speed of adjustment to
variations in excess liquid funds being share
buybacks. The planning which is necessary in
order to make the decision to acquire another
company or expand organically is much more
complex than that required when it comes to
changing the level of dividends. At the same
time, in a highly competitive environment,
when an investment opportunity arises, the
company which succeeds is the one that
moves first. Therefore, investment-type cash
spending, such as acquisitions and increases
in capital expenditure, happen faster than
other types of spending, such as share
buybacks. The finding that share repurchases
are characterised by the slowest speed of
adjustment to changes in excess cash is
consistent with firms tendency to embark on
so-called buyback programmes which are
typically implemented over long periods of
time.

This type of analysis of company cash reserves

follows the methodology used by Harford in the
Journal of Finance (2005). It should also be noted
that each spending model includes the excess as
well as the sufficient cash levels at companies
disposal. This makes it possible to disentangle the
effects of the two types of cash reserve. In order to
capture how quickly the spending behaviour adjusts
to increases in excess cash, each spending model
accounts for the size of the two types of cash
reserve over a period of three years before the time
of spending.

Cass Business School

February 2012

The Optimal Spending Strategies

ccording to the Bank of England, the

UK economy is set to start expanding
in the first quarter of 2013. The Gross
Domestic Product (GDP) growth rate is
expected to increase to 2.0% by Q1 2013 as
compared to the GDP growth rate forecast for
Q4 2011, which was equal to 1.3% at the time
of writing. 7 Once the economy starts
recovering, companies will come under even
more pressure to use their cash in one form or
another. Keeping the cash at hand would only
earn a maximum return equal to the risk-free
rate. However, simply disposing of these cash
reserves when an opportunity arises may not
prove to be the most profitable strategy to
adopt either. Are certain spending strategies
superior in terms of the financial performance
in which they result?
In order to answer these questions, we
examined the share price performance of the
spending strategies adopted by the companies
which, according to our cash model, possess
excess cash. 8 In order to assess the share

The forecasts were obtained from the Bank of

Englands website.
8

This report focuses on the five primary ways in

which companies can dispose of cash, i.e. M&A (on
which the sample companies spent an aggregate
amount of $3.6 trillion over our sample period),
share buybacks (on which the sample companies
spent an aggregate amount of $2.7 trillion over our
sample period), increases in dividends (the sample
companies increased dividends by an aggregate
amount of $254 billion over our sample period),
increases in capital expenditure (the sample
companies increased dividends by an aggregate
amount of $415 billion over our sample period) and
reduction in long-term debt (the sample companies
reduced their leverage by an aggregate amount of
$583 billion over our sample period). Since most of
the spending strategies are not mutually exclusive,
i.e. companies can simultaneously spend excess
cash on more than one spending strategy, we
devised a methodology whereby it is possible to
choose the strategy with the highest importance in
terms of the amount of excess cash devoted to it
during the years when companies used cash for a
combination of cash utilisation methods. In

price performance of companies which chose

a given spending strategy, we estimated the
so-called Buy and Hold Abnormal Returns
(BHAR). 9 In the context of this study, the
BHAR share price returns represent the gains
which would result from a strategy of investing
in a portfolio of all of the firms which opted for
a given spending strategy during the last
month of the year in which the cash spending
took place and then selling this investment
after 36 months. The average share price
performance of companies which followed a
given spending strategy in the first year after a
period with excess cash is presented in Exhibit
3. Exhibit 4 presents the corresponding riskadjusted performance, i.e. the average
abnormal returns associated with each
strategy deflated by the standard deviation of
the returns of all of the companies which
selected the same spending strategy. The
analysis of risk-adjusted returns makes it
possible to measure the abnormal returns per
unit of risk that a given spending strategy can
generate on average. Both Exhibits 3 and 4
clearly indicate that those companies which
kept hold of their excess cash reserves
instead of utilising them in one way or
another generated the lowest abnormal
returns per unit of risk, equal to -15%.

particular, for each of the years during which more

than one spending method took place, we selected
the spending strategy for which a company devoted
the highest portion of cash. Also, it should be noted
that in order to avoid double-counting, To evaluate
the performance of companies which chose a given
spending strategy, we only followed the spending
behaviour of those companies from our sample
which possessed excess cash in the first year of a
three-year period. Please refer to the Data and
Methodology section of this report for further details
on the performance evaluation methodology.
According to this methodology, we have a sample
of 107 companies which performed M&A, 145 which
performed share repurchases, 435 which increased
dividends and 692 which decreased long-term debt.
9

Please refer to the data and methodology section

for further details on the calculation of BHAR.
6

Cass Business School

February 2012

The performance results also show that,

among
the
five
spending
strategies
investigated in this report, the best performing
cash spending methods are M&A and
buybacks. The maximum average abnormal
return from buybacks (7%) is realised as early
as two years after the strategy is implemented,
whereas
the
maximum
return
from
acquisitions, which is comparatively higher
(11%), takes longer to materialise. The returns
which these strategies generate on a riskadjusted basis are almost identical, namely
15% and 14%, respectively. It should be
noted, however, that the use of excess funds
for the purpose of returning cash to investors
is not directly comparable to spending on
M&A. The latter spending option constitutes a
way of investing excess funds in order to
improve or expand business operations. In
contrast, the former option represents a way of
rewarding current shareholders by paying out
the extra funds generated by a companys
business operations. It follows that the two
types of spending strategy should not be
regarded as competing methods of cash
utilisation, but rather as complementing each
other. Financial theory suggests that
companies should only invest in projects which
are profitable, i.e. those which have positive
net present value. However, when a company
is not faced with any viable opportunities to
improve or expand, it is better to return the
extra funds to shareholders as investing in
zero or negative net present value projects will
result in poor financial performance.
The two strategies which could be considered
as substitutes for buybacks and M&A increasing dividends or expanding a business
organically by increases in capital expenditure
- can result in abnormal risk-adjusted returns
amounting to 4% and -2%, respectively. We
note that the average index-adjusted returns
generated by these two strategies are very
close to 0, i.e. at par with the index return. We
conclude that neither of these spending
strategies appears to generate superior
returns for shareholders, but nor do they
destroy value on average. We note that capital
expenditure consists of both spending in order
to maintain ordinary business activities, such

as
replacing
defunct
equipment
and
machinery, as well as to expand business
operations. In order to be directly comparable
to the other spending strategies, we need to
disentangle the capital expenditure which is
used to maintain company operations from
that which is used to grow the business
organically. We distinguish between these two
types of spending by taking the capital
expenditure less depreciation as a proxy for
spending for the purpose of expansion.
In summary, the analysis suggests that
companies which keep excess cash at
hand rather than spending it perform worst
and are accordingly penalised by the
market (-15%). In contrast, companies
which are able to seize profitable
investment opportunities through engaging
in acquisitions or returning funds to
shareholders, when they do not face any
viable opportunities to expand, outperform
the firms which follow other spending
strategies. The reason why companies
which use excess cash for organic growth
neither out- nor underperform their
respective benchmark could be that this
form of business improvement or
expansion is not a strategy that is
aggressive enough to generate returns in
excess of the market over a three-year
period. It is also plausible that companies
lack efficient communication techniques
with regard to their internal growth
strategies. Whereas takeovers and share
repurchases tend to be highly publicised
events and are therefore less likely to
remain unnoticed by investors, increases
in expenditure for organic growth are much
more difficult for investors to identify. The
performance results associated with
spending on organic growth could suggest
that companies are not able to convey their
spending plans adequately to the investor
community.

Cass Business School

February 2012

Exhibit 3: Buy-and-hold returns for each spending strategy performed in the first year following a period with positive excess cash

Buy-and-hold returns

15%

11%

10%

7%

5%

3%

1%

0%

0%

7%

0%
-5%

-1%

-1% 0% 0% 0%
-5%

-10%

0%

-1%
-5% -5%

-9%

-3%

-4%

-1%
-4%

-5%

-10%

M&A

Month 12
Capex
Dividends

-9%

-11%

-15%
Month 1
All with excess cash

-1%

-2%

Buyback

Month 24
Reduction in long-term debt

Month 36
No spending

Exhibit 4: Buy-and-hold returns adjusted for risk

All with
excess cash

M&A

Capex

Dividends

Buyback

Reduction in
long-term debt

No spending

Month 1
Month12
Month 24

-4%
-10%
-5%

1%
-4%
2%

-3%
-11%
-7%

-2%
-11%
0%

-4%
2%
16%

-2%
-10%
-7%

-55%
-27%
-19%

Month 36

-1%

14%

-2%

4%

15%

-1%

-15%

Exhibit 3 presents the performance in terms of the average returns of the five different portfolios consisting of all of the companies which opted for a given spending strategy in
order to utilise the excess cash at their disposal as well as that of those companies which decided to keep the excess funds to hand. In addition, Exhibit 4 presents the riskadjusted performance (i.e. the average return divided by the standard deviation of returns) of the aforementioned portfolios The M&A portfolio includes all of the sample
companies which used their excess cash for the purpose of M&A and in which the method of payment was all cash; the Capex portfolio includes all of the sample companies
which used their excess cash for the purpose of organic growth through capital expenditure; the Dividends portfolio includes all of the sample companies which used their
excess cash for the purpose of distributing it in the form of cash dividends; the Buyback portfolio includes all of the sample companies which used their excess cash for the
purpose of repurchasing a portion of their shares; and the Reduction in long-term debt portfolio includes all of the sample companies which used their excess cash for the
purpose of reducing their indebtedness. It should be noted that, in order to be included in this graph, each spending strategy must have been adopted in the first year following
a period of positive excess cash. The returns have been calculated on the basis of the Buy-and-Hold Abnormal Returns (BHAR) methodology. Please refer to the Data and
Methodology section of this report for a detailed description of the method used for distinguishing between the different spending options as well as that used in order to
evaluate the share price performance of each portfolio.
8

Cass Business School

February 2012

Data and Methodology

The initial study sample consisted of all nonfinancial and non-utility companies which were
listed on the London Stock Exchange at any
point in time between 1996 and 2010.10 This
list of companies and the necessary financials
were collected from Datastream. In order to
estimate the so-called sufficient cash reserves
at a firms disposal, we adopted a
methodology similar to that used by Harford in
his study from 1999, Corporate Cash
Reserves and Acquisitions, published in the
Journal of Finance. A separate cash model
was estimated for each of the eight industry
groups included in the sample. We excluded
the Financial and Utilities sectors due to the
fact that the cash policies of companies
operating in these industries could be affected
by different regulatory frameworks.

rated UK corporate bonds, obtained from

Bloomberg; the six and 12 month UK
Certificate of Deposit rate, which is measured
on a yearly basis and obtained from
Bloomberg; and the after tax cost of debt per
company, which was also obtained from
Bloomberg. 13 The cash models were used in
order to measure the level of sufficient cash
which companies need to perform their
ordinary business activities. The difference
between the actual and sufficient cash
reserves is defined as the excess cash level
which companies are free either to keep at
hand (i.e. not spend) or use for the purposes
of performing acquisitions and/or buying back
shares,
increasing
capital
expenditure,
reducing long-term debt and/or increasing
cash dividends.

The industry-specific cash models are

presented in Exhibit 5. 11 We control for the
following variables in each of our eight cash
models: the ratio of net working capital
(measured as the working capital minus cash
reserves) to net assets; the ratio of total debt
to net assets; the Bank of Englands liquidity
index; 12 the spread between AAA and BBB

In order to evaluate whether the accumulation

of excess cash can exert any influence on
firms spending patterns, we performed a
regression analysis. We constructed five
spending models in order to investigate the
type of relationship which exists between
excess cash reserves and each of the five
spending options.14 The dependent variable in
each model is the annual amount spent on a
given spending strategy divided by the
average amount that the company spends on
the same strategy. 15 The additional factors
which were tested in the model are as follows:

10

Note that the majority of companies in the sample

are registered in the UK. In 2010, 94% of the
sample was made up of UK companies, accounting
for 80% of the total cash reserves.

11

Cash Reserves are defined as the cash plus

marketable securities reported on a companys
balance sheet and Net Assets as the total assets
reported on a companys balance sheet minus the
cash reserves.

12

This liquidity index is a simple, unweighted mean

of nine liquidity measures normalised for the period
1999-2004. According to the Bloomberg database,
the indicator is more reliable after 1997 as it is
based on a greater number of underlying measures.
Liquidity measures incorporate bid-ask spreads,
return to volume ratio, and the Liquidity premia. This
single index summarises all these measures. The
index combines three key market measures -- the
gaps between bid and offer prices on bonds,
currencies and stocks, the ratio of market returns to
trading volumes, and spreads in the credit market.

13

Company financials are measured as of one year

before the current period.
14

These spending models are based on the

methodology presented by Opler et al. (1999) in the
study The determinants and implications of
corporate cash holdings. published in the Journal of
Financial Economics.

15

The cash spending models include both the

current and previous (relative to the year of
spending) levels of excess and sufficient cash. In
addition, it should be noted that both the sufficient
and excess levels of cash were tested for statistical
significance in each of the spending models in order
to disentangle the effects of the two types of cash
reserve on company spending patterns.
9

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February 2012

1) In the models for acquisitions and capital

expenditure: the Purchasing Managers Index
(PMI); 16 the year-on-year sales growth was
included in order to capture the need for
spending funds for the expansion of operating
capacity; the market-to-book ratio was used in
order to capture the future growth
opportunities encountered by the company.
2) In the model for share buybacks: the
market-to-book ratio; the level of cash
dividends to net assets was included in order
to control for the fact that some managers may
perceive share repurchases and dividend
distributions as substitute methods of
rewarding shareholders; the degree of firm
leverage was included because the decision to
repurchase shares could be viewed not only
as a way to reward investors, but also as a
way to change the mix of debt and equity used
to finance the operations of the business.
3) In the model for dividend distributions: the
market-to-book ratio; and the level of cash
dividends to net assets as of one year before
the current period.17
4) In the model for reductions in long-term
debt: the market-to-book ratio; the ratio of
long-term debt to net assets was included in
order to control for the fact that companies
with highly leveraged business operations are
faced with a higher likelihood of experiencing
financial distress or bankruptcy and thus more
inclined to reduce their leverage. In order to
evaluate company share price performance,
we calculated the Buy-and-Hold Abnormal

16

The PMI is produced by Markit Group Limited and

the Institute for Supply Management. It is an
indicator of financial activity which measures the
acquisitions of goods and services by companies
and is constructed on the basis of monthly surveys
of businesses. This index was obtained from
Bloomberg.
17

The latter variable is identified as an important

determinant of dividend distributions by previous
studies (see e.g., Lintners 1956 study, according to
which the change in dividends is presented as a
function of a companys current income, the last
periods dividend payments, the companys target
payout ratio and its so-called speed of adjustment,
i.e. the rate at which the company changes the level
of dividends between the current and the ultimate
target level that managers would like to pay out).

Returns (BHAR). BHAR can be defined as the

average multi-year return from a strategy of
investing in all firms that complete an event
and selling at the end of a pre-specified
holding period versus a comparable strategy
using otherwise similar non-event firms (see
e.g., Mitchell and Stafford, 2000). An
advantage of using BHAR is that this approach
to
measuring
company
share
price
performance is closer to investors actual
investment experience compared to the
periodic rebalancing which other approaches
to share price performance analysis involve.18
Six different portfolios of companies were
constructed on the basis of the particular
spending option which they chose: Portfolio 1
includes companies which opted for M&A; 19
Portfolio 2 includes companies which opted for
organic growth; Portfolio 3 includes companies
which opted for a decrease in leverage;
Portfolio 4 includes companies which opted for
share buybacks; Portfolio 5 includes
companies which opted for an increase in cash
dividends; Portfolio 6 includes companies
which kept the excess cash at hand. 20 The
calculation of BHAR is performed as follows:
,

where , represents the return on bidder i

over period T and , represents the return on
the benchmark index over the same period.

18

We removed the extreme values which result

from the BHAR calculation.

19

Only acquisitions with 100% cash are considered

as a cash utilisation strategy.
20

We adjusted the BHAR by subtracting the returns

to the FTSE Share index which were closest in
terms of average market capitalisation to the
specific company being benchmarked. In order to
avoid double-counting, when evaluating the
performance of companies which chose a given
spending strategy, we only followed the spending
behaviour of those companies from our sample
which possessed excess cash in the first year of a
three-year period. BHAR were measured over a
period of 36 months. The BHAR corresponding to
each portfolio are equally-weighted.
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Cass Business School

February 2012

Exhibit 5: Industry-specific factors determining corporates sufficient cash reserves

Company-specific factors

Factors
Current cash flow

Managements
expectation of the
degree to which future
cash flow will meet the
need for planned
investments

Size

Growth opportunities

Basic
Materials

Cost of debt

Economic productivity
Economic growth
Market liquidity

Industrials

Consumer
Goods

Consumer
Services

Oil &
Gas

Technology

Telecommunications

Indebtedness

Liquidity

Macroeconomic
factors

Healthcare

Exhibit 5 shows the different factors which affect the size of sufficient cash reserves for each of the sample industries. These factors are determined on the basis of eight industry-specific
models of sufficient cash. Current cash flow is measured as each companys net cash flow deflated by net assets; Managements expectation of the degree to which future cash flow will
meet the need for planned investments is measured as the consensus analyst forecast of future net cash flow one and two years ahead of the current period; Size is measured as the
natural logarithm of total assets; Growth opportunities are measured as each companys current market-to-book ratio; company Indebtedness is measured as each companys long-term
debt deflated by net assets as of one year before the current period; the Cost of debt for each company was obtained from Bloomberg; Liquidity is measured as the net working capital
deflated by net assets; Economic productivity is measured as the UK productivity index, provided by the Bloomberg database; Economic growth is measured as the annual change in the
MSCI World Index; and Market liquidity is the Bank of Englands liquidity index. For further details on how each variable is constructed please refer to the Data and Methodology section
of this report.
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Notes on Authors

Anna Faelten, Senior Researcher at the

M&A Research Centre. She was previously
the editor of Deal Monitor and has recently
completed an Executive MBA programme at
Cass Business School.

Valeriya Vitkova, Cass MARC researcher,

currently pursuing a PhD programme with a
focus on Corporate Finance at Cass
Business School.

Dr Naaguesh Appadu provided additional

research assistance. He is a Cass MARC
researcher who recently completed a PhD on
The Determinants of the Fixed and Floating
Rate Debt: a case for UK non-financial firms
at Middlesex University.

Scott Moeller, Director of MARC and Professor in the Practice of Finance. His research and
teaching focuses on the full range of mergers and acquisitions activities.
Contact: cassmarc@city.ac.uk

Cass Business School

February 2012

Cass Business School

106 Bunhill Row
London EC1Y 8TZ
Tel +44 (0)20 7040 8600
www.cass.city.ac.uk/marc

Cass Business School

In 2002, City Universitys Business School
was renamed Sir John Cass Business School
following a generous donation towards
the development of its new building in
Bunhill Row. The Schools name is usually
abbreviated to Cass Business School.
Sir John Casss Foundation
Sir John Casss Foundation has supported
education in London since the 18th century
and takes its name from its founder, Sir John
Cass, who established a school in Aldgate in
1710. Born in the City of London in 1661, Sir
John served as an MP for the City and was
knighted in 1713.