Can Changes in the Cost of Cash Resolve the Corporate Cash Puzzle?

To answer this question, we first create a measure of the opportunity costs of holding liquid assets as the wedge between the cost of capital and the return of firms’ cash portfolio. Exploiting both cross-sectional and time-series variation of opportunity costs, we estimate a negative effect of opportunity costs on the cash-to-assets ratio of U.S. nonfinancial Compustat firms. We then use the estimate to predict changes in aggregate cash holdings for 1945-2013 and find that they closely match actual changes in cash holdings over that period. Differences in opportunity costs also explain cross-country differences and within-country time variation of cash-to-assets ratios of firms in the five largest European economies and Japan. The increased sample length for the U.S. results and the international results make clear that current U.S. cash holdings are not abnormal, neither in a historical nor in an international comparison.