The Persistence and Pricing Implications of Changes in Multinational Firms’ Foreign Cash Holdings

• In Event: Taxes and Financial Reporting

Abstract

Using a hand-collected sample of U.S. multinational firms’ foreign and domestic cash holdings, we evaluate the association between changes in foreign and domestic cash and future earnings. Because the changes in the cash holdings are components of cash flows which itself is a component of current period earnings, a higher coefficient on the change in cash components means higher earnings persistence. In contrast to the common belief that accumulating cash in foreign subsidiaries is suboptimal, we find that changes in foreign cash are as persistent as changes in domestic cash. We further document that foreign cash changes are more persistent when foreign operations offer better growth opportunities and when repatriation taxes are lower. Next, we investigate whether investors efficiently price the earnings persistence implications of changes in foreign and domestic cash. Our results suggest that investors underreact to positive changes in foreign cash. Further, we find that investors’ under-reaction to positive foreign cash changes is more pronounced when foreign growth is higher and repatriation taxes are lower. Overall, our evidence suggests that retaining cash in foreign subsidiaries, on average, does not lead to lower future earnings. Our finding that investors underestimate the persistence of positive changes in foreign cash is consistent with calls for more transparent disclosure on foreign cash and foreign operations.

Authors

• Xi Chen, University of Houston-Houston

• Peng-chia Chiu, The Chinese University of Hong Kong

• Terry J Shevlin, University of California-Irvine