Foreign Cash: Taxes, Internal Capital Markets and Agency Problems

U.S. multinational corporations (MNCs) hold significant amounts of cash abroad. Using a handcollected sample of large U.S. MNCs, we find that the percentage of cash trapped overseas has a significantly negative impact on the market value of a firm’s cash holdings. Such negative effect is more pronounced when firms are subject to higher repatriation tax rate, when firms have higher costs of raising capital in the domestic market, when firms operate in less competitive industries, and when CEOs’ interests are less aligned with those of shareholders. We also find a firm’s domestic investment is only sensitive to its domestic cash flows while insensitive to its foreign cash flows. The sensitivity of domestic investment to domestic cash flows is more pronounced when firms have a higher portion of cash trapped overseas. Furthermore, we show that companies with more foreign cash are more likely to make cross-border acquisitions that result in lower shareholder value. Taken together, our findings support the hypothesis that holding large amount of cash abroad reduces a firm’s financial and investment flexibility in the domestic market and creates more agency problems associated with the use of foreign cash. As such, investors place a discount on the market value of the company’s cash holdings.