Why companies hoard cash
By Alexander Chepakovich, CFA 2011-11-11Have you ever wondered why so many highly profitable companies (like Microsoft and Apple, for example) have so much cash and marketable securities on their balance sheets? Is it because they are afraid of a sharp downturn in their businesses or plan major acquisitions? My answer: none of the above. I think there is just one motive behind this and it stems from the fact that most of their compensation the top management of technology (and not just technology) companies get from stock options.
It is a widespread practice (supported by management consultants) to award stock options to managers and top performing employees to get them interested in showing excellent results that boosts company's share price. In theory this aligns their interests with interests of ordinary shareholders. And align it does: everything in order to get that share price higher. Even at the expense of much lower return on equity (ROE).
ROE is the highest when the company has a certain level of leverage (i.e. when it has debt) – this is, of course, if the return on assets (ROA) exceeds the cost of debt. Adequate leverage is, therefore, is beneficial for most companies, and is highly beneficial for the most profitable ones.
Top managers compensated through stock options, however, seem to not care much about what is the best for companies – rather they care only about what is the best personally for them. Apple, for example, had $81.5 billion of cash and marketable securities on its balance sheet as of September 24, 2011, earning on them just 0.5% per annum. I am sure that shareholders could find much better applications for this money – just give it back to them through dividends.
Ordinary shareholders gain not just from increase in the company's share price but also from dividends the company pays. Boards of directors of companies should finally recognize that stock option compensation of the company's top management is a suboptimal measure from the point of view of shareholders, whose interests the boards are supposed to protect. Absurdly-high payouts received by managers of some companies through stock option programs are not commensurable with benefits of share ownership by ordinary shareholders. Besides, such benefits are further hampered by sub-optimal capital structure of many companies.