Corporate liquidity has hit record levels this year as companies sit on a huge cash reserve, bolstered by government emergency funding. We look at how and when businesses might resume investing for an economic recovery. Words by David Stevenson.
Businesses in the UK now hold more money than at any time since official records began, and they are little different from their peers across the world (see our full analysis here). For now, the financial fallout from COVID-19 is forcing companies to keep liquidity buffers against the threat of falling profits and cash flow. But once the worst is over – however far away that might currently feel – thoughts will turn to how to spend it. We examine what might happen to all that cash, and start with a look at the numbers.
Any discussion within businesses about how to spend the huge cash reserves built up in recent years may be some way off.
There will come a time, probably next year, when businesses will be looking to make investment decisions to boost revenue, shape new markets and steal a march on competitors. But this is likely to coincide with a wider debate about how all this cash can support the post-COVID-19 economic recovery.
During the pandemic, western governments have exerted more control over their citizens than has probably been seen since the Second World War.
This only makes it more likely there will be calls from across society for politicians to have more of a say over how the corporate sector spends its cash, especially when so much of it has come from emergency funding.
As Mark Littlewood, director general of the Institute of Economic Affairs, says, “National crises of any sort – be they wars or pandemics – tend to lead to a growth in the power, influence and intervention of the state. That’s certainly the experience of the First and Second World Wars.”
To put UK companies’ £900bn gross figure in context of this potential political debate, during its 2019 election campaigning, the Conservative Party promised “40 new hospitals will be built across England”, which the Institute for Fiscal Studies estimated would cost up to £24bn.
Darren Jones, MP, chair of the Business, Energy and Industrial Strategy Committee, says: “If the taxpayer is increasingly involved in supporting businesses then we should be considering how far the government should get involved and how this would be managed.”
Paul Ashworth, chief North America economist at Capital Economics, a research firm, says that, globally, attitudes toward business are changing as part of a “backlash against capitalism in response to the increase in income inequality. We could see government playing a bigger role in advanced economies in the coming decades – with higher taxes on the rich and more redistributive spending.” Jones suggests that, “With it being necessary for the government to potentially step in to support strategically important businesses, there are strong grounds for the government to consider taking equity in these so that taxpayers would then be able to share in their future success.”
Many commentators expect governments to use a combination of carrot and stick to shape private sector spending decisions. Andrew Harrop, general secretary of the Fabian Society, argues that because “UK business taxation is a mess”, we should make the system “rational and fairer. We could easily go back to the OECD medium level with corporation tax, which would bring money from the most successful companies. Then you could incentivise behaviours you want by using the money on tax credits for digital investment or on adult skills training.”
Others would leave it up to managers. “Companies might have got this right”, points out Littlewood, “in sharp contrast to the government, which runs up modest debts in good times and colossal debts in bad. Fiscal assistance compensates for government policy changes that have curbed companies’ ability to operate normally. I don’t believe government has a right to demand how they can spend it.”
Any debate about the relative merits of businesses spending money on an R&D centre in a low-income area, say, or on a nationwide coding apprenticeship would be nothing to the anger caused if it seems that large chunks of this cash pile go on executive salaries and bonuses. A July report by CGLytics, a governance data provider, examined the executive pay policies of companies in the Russell 3000 index (the 3000 largest public companies in the US) and, while acknowledging that some companies did make salary reductions in response to COVID-19, concluded that CEOs’ and executives’ “compensation packages predominantly consist of cash bonuses and equity awards. Even though 80% of the Russell 3000 companies have disclosed 2019 compensation for executives, we have not witnessed any companies making adjustments to these ﬁgures in light of the crisis, even for companies in hard-hit industries.” Actions like this are likely to be revisited under far greater public glare next year.
Harrop would go further than just naming and shaming companies paying large bonuses at the top when laying off workers below. “There’s no mechanism in the labour market to help average workers share in the rewards of successful companies,” he says. “That would require considerable new regulation making it easier for trade unions or other sorts of workforce representation to engage with management, so that – in terms of the cash piles you’re talking about – the workforce shares that success.”
Areas of focus
There will undoubtedly be debates and flashpoints that are impossible to predict, but one of the key places that politicians, policymakers and the public will expect cash to flow is into training and tangible improvements in communities, rather than on headline grabbing expensive M&A deals.
Jones counsels: “While businesses are understandably concerned about the continuing COVID-19 impact and fearful of the fall-out from a no-deal Brexit, they will only succeed if they use their spending power to invest not only in infrastructure but also in skills.”
Charmian Love, co-founder and chair of B Lab UK, says that, for too long, companies have sacrificed long-term value creation to generate short-term results. She is part of a growing movement calling on businesses to allocate more capital to innovation focused on the UN 17 Sustainable Development Goals, which include ending poverty, ensuring clean water and sanitation, and providing clean and sustainable energy, and that cash hoards are now giving companies the chance to do this.
One other flashpoint will likely be around returning cash to shareholders. For example, in March the Bank of England set up a COVID-19 corporate financing facility where it bought commercial paper from companies with an investment grade rating. Companies in receipt of this were told to stop dividends, among other measures, before May if they planned to hold the funds for more than a year.
Many paid out before the May deadline. While conforming to the letter of the law if not the spirit, that prompted angry outbursts. Jones says: “Where there is taxpayer support, the public would rightly expect businesses to act in good faith and think twice before paying out dividends. While the Treasury is at fault for not having imposed conditions, businesses should not be pushing money out to shareholders.”
However, like many of these flashpoints, this is not a cut and dried issue. Dividends are a vital source of income for pensioners, charities and local authorities.
Finally, policymakers will be keen to use a “COVID-19 reset” to push for higher productivity, which is a major factor behind economic success. This is also a concern likely to be shared by executive teams as well – everyone will be trying to do more with less. As has been well-discussed and documented, the UK has a particular problem with productivity. As the chart below shows, productivity growth ground to a halt soon after the great recession of 2008-09.
Meanwhile, UK capital investment is around 17% of GDP versus the global average of almost 25%, according to TheGlobalEconomy.com data. That compares with Australia, for example, which is much higher on the capex list despite its corporates also having a reputation for hoarding cash.
Iain Wright, Director for Business and Industrial Strategy at ICAEW, understands the dilemma businesses face. “Businesses holding onto cash in a volatile economic situation is entirely rational and will probably increase their chances of short-term survival. However, the links between investment, productivity growth and rising living standards are clear. A failure to invest will result in stalled productivity improvements, higher risk of business obsolescence and lower living standards,” he says. More worryingly, he goes on to warn, “If collectively businesses do not invest that massive cash pile, the 2020s could be the decade of falling living standards.”
So would investment of a large chunk of UK corporate cash help the country to catch up, output per worker-wise, with its peers? That boils down to why productivity growth has stalled, says Littlewood. “In 1993 to 2003 (a period of strong productivity growth), the regulatory climate was easier to comply with than it is now,” he says. “You might argue that’s a good thing. Or you might think, especially in the highly productive parts of the economy such as financial services, that we’re spending a vast amount of time complying, and rather less of our time producing. You’d expect that to have downward impact on productivity.”
Wright pushes back on this view, saying, “It’s not that all regulation is inherently onerous or negative. It is subjective and one person’s red tape is another’s opportunity. But a minimal regulatory environment tends to favour the large business over the small, the status quo over the disruptive newcomer and the powerful over the embryonic. A proportionate regulatory system is akin to the brakes on a car: brakes don’t make a car go slower; they increase the potential speed of a car but in a safe way.”
Looking forward, Littlewood considers that “the recipe the government should be looking for – when we finally emerge from this lockdown – would be a much more liberalised regulatory environment post Brexit, especially for those sectors that have historically shown to be the most productive. Indeed, we might bounce back better than, say, our European neighbours because we’ve historically got a more flexible labour market.”
Whatever 2021 holds, it’s clear that executive teams are going to have far more than just their board members scrutinising the decisions they make. There’s probably no time like the present to start preparing for a very different future.
For more on this topic, our article Corporate Cash in Numbers features four charts showing the pandemic’s impact on company cash reserves.