Apple and the problem of too much cash

From time to time, some well-doing companies fall into a
happy dilemma: What to do with the vast pile of cash they earned?

Apple just announced that it will be spending significant
portion of its $100 billion cash holding to give it back to its shareholders,
paying a quarterly dividend beginning in Apple’s fiscal fourth quarter, which
starts July 1, as well as a three-year stock buyback program.

Still, its remaining half, $50 billion, is by far the
largest cash holdings among its peers. Oftentimes, firms are blamed for holding
too much cash. But what leads to large cash holdings?

On one hand, shareholders in well-governed firms feel
comfortable with managers keeping large amount of cash inside the firm and using
it wisely to seize future investment opportunities. On the other hand, managers
in poorly-governed firms, where shareholders have very little influence, may
pile cash in order to squander it. Given that two opposing situations lead to
the same result, it is often difficult to decide the right amount of cash
holding.

Cash has two major aspects in business: insurance against
liquidity shock (e.g., financial crisis) and granting discretion to managers.
Often managers claim that they need to hold a lot of cash to seize business
opportunities and guard against rough times. Sometimes, this is an excuse to
gain more discretion on using funds, and invites conflict with shareholders. A
notable case was Kerkorian vs. Chrysler: In 1995, Chrysler was sitting on $7.5 billion
in cash. Management said it needed this cash to provide sufficient liquidity.
Kerkorian (shareholders), on the other hand, said that $2.5 billion in cash and
$ 2.5 billion in lines of credit would be enough for this purpose. 

As one can see, an alternative to cash for liquidity
insurance is to rely on lines of credit. It provides funds in times of
liquidity needs, while limiting abuses of funds (because drawing from lines of
credit invites the attention of banks – and the media – and are subject to
covenants). While fully relying on lines of credit may entail some risk (as we
have seen in recent banking crisis), unloading part of the need for liquidity
onto lines of credit may be a sensible thing to do.

Returning to Apple’s situation, $50 billion is still a lot
of cash. But Apple has been growing fast and the company’s claim to hold onto
cash to seize future investment opportunities is justifiable. This is especially
the case since Apple is considered to be a reasonably well-governed firm
(except for its option-backdating scandal, which was minor relative to
other major corporate scandals by other firms). So, shareholders may feel less
nervous about management sitting on large pile of cash.

For corporate governance perspective, Apple’s decision to
return money to stakeholders should be a good thing. It reduces shareholder
risk of manager’s misuse of cash. Interestingly, Apple’s stock price slightly
fell immediately after the announcement. The market may interpret the move as
Tim Cook’s vision of Apple heading towards less innovative course.

Apple may be gradually joining the mature groups
of firms with fewer new investment opportunities, similar to Microsoft in 2004.
Up to this point, Microsoft and Apple have had very different business
strategies, to be sure: Microsoft focuses more on evolutionary products where
small improvements are made one-step at a time. Apple under Steve Jobs has
been taking quantum leap each time it introduces a new product. By giving
up substantial amount of cash, Cook may be signaling the market that Apple’
growth strategy may be more in line with Microsoft’s in the future.

As the end of the trading approached, Apple stock price
substantially increased from last week’s closing price. So, tentatively, it
seems that the market considers the former (limiting misuses of cash) is the
more important factor in today’s Apple’s decision.

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