In fact, a sharp increase in firms’ savings behavior has changed the net position of the (nonfinancial) corporate sector vis-à-vis the rest of the economy. Why have firms in the business of producing goods or services become lenders? This is quite at odds with traditional models of corporate finance, which suggest that firms issue debt and equity to fund their operations and finance their investment projects. But successful firms appear to accumulate financial assets even when they are issuing equity, and these financial holdings are mainly in a very liquid form that pays a low return. This poses a conundrum, since holding financial assets while maintaining outstanding equity positions is expensive for the firm. In this article, Roc Armenter looks carefully at the data to learn which firms have been responsible for the rise in corporate savings and then briefly discusses the costs and benefits of equity relative to debt.
This article appeared in the Third Quarter 2012 edition of Business Review.View the Full Article