Apple’s cash and short-term investments have plunged to $48 billion as of the end of June 2022 from $107 billion at the end of 2019 — a decline of 55%, but, according to a theory aid out several decades ago by Michael Jensen, an emeritus professor of business administration at Harvard Business School, that’s a positive development for both the business and the company’s shareholders.
In a now-famous 1986 article in the American Economic Review, Jensen argued that companies would be less efficient to the degree they hoarded cash above and beyond what was needed for current operations.
Why would too much cash be a bad thing? Jensen theorized that it encourages corporate managers to engage in foolish behaviors. Jensen argued that shareholders should try to “motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies.”
That’s the theory. But does it hold up in practice? To get insight, I reached out to Rob Arnott, founder of Research Affiliates. Arnott was co-author in 2003 (with Cliff Asness of AQR Capital Management) of a study that provided empirical support for Jensen’s theory. Their study, which appeared in the Financial Analysts Journal, was entitled “Surprise! Higher Dividends = Higher Earnings Growth.”
They analyzed corporate earnings growth over 10-year periods between 1871 and 2001 and found that earnings grew the fastest following years in which companies’ dividend-payout ratios were the highest. Companies that hoarded their cash instead of distributing it to shareholders performed more poorly, on average.
MacDailyNews Take: Buybacks and dividends shrink the cash hoard, imposing discipline (which Apple does not lack, having famously passed on several acquisitions such as, for two of many examples: YouTube in 2006* and Tesla in 2017).
Jensen’s theory is that if/when Apple needed cash, it would simply utilize the debt or equity markets, which would create some measure of accountability on new projects or investments a company might want to make. Again, Apple under Steve Jobs and Tim Cook, already has, it can be argued, too much discipline when it comes to pulling the trigger of transformative acquisitions.
*On October 9, 2006, Google purchased YouTube for $1.65 billion. YouTube’s sales for the first quarter of 2022 grew 14%, to $6.87 billion.
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