Did Unlimited FDIC Insurance Affect Corporate Cash Holdings?

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1 Did Unlimited FDIC Insurance Affect Corporate Cash Holdings? Anna-Leigh Stone a,* a Culverhouse College of Business, University of Alabama, Tuscaloosa AL 35487, United States May 2013 Abstract Before its expiration, Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act provided unlimited FDIC insurance on non-interest bearing accounts. This paper examines whether the aforementioned Act and the Transaction Account Guarantee Program that preceded it had a significant influence on corporate cash holdings from 2002 until Using both time series and panel data techniques, an increase in both corporate cash holdings and non-interest bearing deposits is shown around relevant times suggesting that companies might have increased cash holdings as a result of the unlimited insurance. Keywords: cash holdings, Federal Deposit Insurance Corporation (FDIC), Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA), Transaction Account Guarantee Program (TAGP) JEL Classification: G3, G32, G01 * Corresponding author. Tel.: ; Fax: address: alstone@crimson.ua.edu (A. Stone) The author would like to thank Benton Gup, James Ligon, and Billy Hankins for helpful comments and suggestions.

2 1. Introduction Recent economic events have left companies with a new objective for short term investments: safety. In the 2012 Association for Financial Professionals (AFP) Liquidity Survey, 77% of respondents indicated that safety was the most important short-term investment objective for companies as compared to 21% who were most concerned with liquidity. As companies are holding more short-term investments, bank deposits are also growing. The AFP reported that in 2012 companies were keeping 51% of their short-term investments in bank deposits, up from 42% in both 2010 and 2011 (AFP Liquidity Survey). In 2008, companies kept just 25% of their cash in bank accounts. One reason for this increase in deposits is attributed to unlimited insurance protection for non-interest bearing accounts. Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) provided unlimited insurance protection for non-interest bearing accounts from December 31, 2010 through December 31, However, the insurance coverage was raised prior to the enactment of the DFA. On October 13, 2008, the Federal Deposit Insurance Corporation (FDIC) passed the Temporary Liquidity Guarantee Program (TLGP). This enacted the Transaction Account Guarantee Program (TAGP), which provided unlimited FDIC insurance coverage on non-interest bearing accounts until December 31, The TAGP was twice extended until June 30, 2010 and finally December 31, In this paper, I investigate the relationship between corporate cash holdings and the TAGP and the DFA, both of which provided unlimited insurance on non-interest bearing accounts. I find corporate cash holdings and non-interest bearing accounts increase around the same time frame and have similar breaks as predicted by the Bai and Perron (2003) analysis. Figure 1 plots two measures of non-interest bearing deposits by quarter from January 2002 until December The shaded regions are from the start of the TAGP in October 2008 until the end of the DFA in December Panel A plots the sum of non-interest bearing deposits across all banks and Panel B 2

3 plots the mean, median, and aggregate ratio of non-interest bearing deposits to total deposits. 1 Both measures show that not only did the sum increase but the fraction of non-interest bearing deposits to total deposits increased as well. Both panels present evidence that increases in non-interest bearing accounts occurred around the passage of both TAGP and DFA. Figure 2 plots two measures of corporate cash holdings. Panel A plots the sum of cash and cash equivalents across companies and Panel B plots the mean, median, and aggregate cash holdings ratio. Similar to Figure 1, there is a slight growth in corporate cash from 2002 until 2008, with a larger increase occurring during the time of the Acts. Thus, there appears to be an increase in both non-interest bearing accounts and corporate cash and cash equivalents during the unlimited insurance periods. I employ several different tests that show increases in both non-interest bearing deposits and cash holdings concurrent with the enactment of both the TAGP and the DFA. Since banks could opt-out of the TLGP (and thus the TAGP) upon its passage and at each subsequent extension, the sample can be divided between banks that provided unlimited insurance and those that did not. Thus, I first use difference-indifferences and show a significant difference in non-interest bearing deposits between these two groups. Second, the Bai and Perron (2003) technique is implemented to test for the presence of structural breaks in corporate cash and cash equivalents and non-interest bearing accounts. If the Acts had an effect on corporate cash holding practices, there should be structural breaks in the aforementioned series around the time each Act was passed. Third, using the double-censored Tobit model I show an increase in corporate cash holdings during the times the Acts were in effect. The remainder of the paper is organized as follows: Section 2 provides a more detailed discussion of the TAGP and the DFA and Section 3 discusses the relevant literature. Section 4 presents the hypotheses and Section 5 presents the data. In Section 6, I outline the models and discuss the empirical results. Section 7 provides additional robustness checks and Section 8 concludes. 1 Non-interest bearing accounts are summed across banks for a given year to create an aggregate measure of non-interest bearing accounts. The same is done for total deposits. 3

4 2. FDIC Unlimited Insurance On October 13, 2008, the FDIC enacted the TAGP, which provided unlimited insurance coverage on noninterest bearing accounts until December 31, It was twice extended until June 30, 2010 and finally December 31, Under TLGP, banks could voluntarily opt-out of the program. The voluntary opt-out was provided because the program was funded by additional fees paid by banks. 2 Once a bank opted-out from the TAGP, it was excluded through each extension of the program. Out of approximately 8,300 banks, 1,110 banks opted-out from the original TAGP, 525 opted-out from the first extension, and 442 opted-out from the second extension. 3 By December 31, 2010, 2,077 companies had opted-out of the program. The FDIC (2011) reported at the end of the fourth quarter of 2010 that 74% of FDIC-insured institutions had opted-in to the TAGP extension through December 31, Williams (2010) reports that 94% of banks with assets of at least $10 billion opted-in to the TAGP initially. This high participation rate of large institutions shows that these banks judged the benefits of the program to outweigh the fees. Given that many corporations hold accounts at large banks that were receiving protection, these corporations banking at the institutions also received the benefit of unlimited insurance. In the 2009 Annual Report, Regions Financial Corporation reported that an increase in non-interest bearing deposits of $4.7 billion was driven by an increase in noninterest bearing deposits from commercial and small businesses. The DFA provided unlimited insurance protection for non-interest bearing accounts from December 31, 2010 through December 31, Unlike the voluntary opt-out of the TAGP, all banks were included in the DFA. Regulation Q, which was established in 1933, prohibited banks from paying interest on business checking accounts. Due to this regulation, non-interest bearing accounts are primarily held by corporations for transaction purposes. In response to Regulation Q, banks also created other types of bank accounts, such as earning credit-rate accounts, in order to circumvent this restriction. Earning credit-rate accounts are checking accounts that waive fees or provide fee-reducing credits to the customer based on the balance of the accounts. 2 For banks that did not opt-out of the program, a quarterly fee of 10 basis points was multiplied by the balances of the noninterest bearing accounts exceeding the $250,000 deposit insurance limit. The fees were increased for the extensions of the TAGP. 3 The opt-out lists are provided online at 4

5 Instead of the companies earning interest on the balance in the accounts, credits are earned that are used to pay down bank fees. The TAGP and DFA both included these accounts as non-interest bearing checking accounts. The DFA repealed Regulation Q, thus allowing corporate accounts to earn interest on checking accounts. Around this time the FDIC began providing non-interest bearing accounts with unlimited insurance. These concurrent events forced companies to balance the additional benefit of the unlimited insurance with the benefit of interest earned on checking accounts. Due to the low interest rate environment, most companies choose the additional benefit of the insurance over the interest accounts. In 2011, Citi claimed that in response to low interest rates and unlimited insurance, only 1-2% of companies were expected to shift to interest bearing accounts (Kelly (2011)). Moreover, Citi claimed that when interest rates begin to rise, companies might have more of an incentive to transfer funds to accounts that pay interest. Dub Newman of Bank of America stated to the degree that a client is focused on [unlimited FDIC insurance], particularly in a lowinterest rate environment where they re not seeing a lot of return regardless of the instrument they re in, that extra safety of FDIC [coverage] has a value to it (Kelly (2011)). It remains to be seen what companies will do with additional funds after the DFA provision ends on December 31, The 2012 AFP Liquidity Survey found that three out of five companies said they have no plans to reduce cash balances in non-interest bearing bank deposits upon termination of the DFA provision. In fact, the FDIC (2013) reported that balances in domestic non-interest bearing accounts increased by $149.1 billion during the fourth quarter of 2012 and a third of this increase ($49.5 billion) was in balances in noninterest bearing accounts above the $250,000 insurance limit. Some industry groups such as the Independent Community Bankers of America and the American Bankers Association asked lawmakers to extend the unlimited guarantee, but there has been no indication that such an extension will occur. 4,5 Given further data after the end of the DFA, it would be of interest to see if the decrease in non-interest bearing deposits is due to 4 Vipal Monga, Cash-Haven Clock Is Ticking, The Wall Street Journal, September 18, As of November 9, 2012 the FDIC posted a PDF document on their website stating that Section 343 of the Frank-Dodd Act was set to expire on December 31, 2012 and deposits held at FDIC insured institutions would only be insured up to $250,000. This can be found at: On December 13, 2012 the U.S. Senate blocked a vote to extend the unlimited insurance on non-interest bearing accounts. 5

6 companies spending the additional liquid investments or if they simply place the funds in other cash equivalents accounts. This is a question for further research. It should be noted that a significant drop in non-interest bearing deposits does occur during the two extensions of the TAGP from January 1, 2010 until December 31, Some large banks did opt-out from the first and second extension of the TAGP. Table 1 displays the mean, median, and aggregate measure of non-interest bearing deposits to total deposits each quarter from 2002 until The statistics for all banks are in the first four columns followed by the statistics for banks that participated in the TAGP. The time frame for the TAGP is shaded in light grey and the DFA period is shaded in dark grey. The only difference between the two groups is found from the fourth quarter of 2008 until the fourth quarter of The ratio for non-interest bearing deposits to total deposits is greater for the firms that participated in the TAGP until the first quarter of For the next year, the ratio decreases substantially demonstrating the magnitude of the banks that elected not to participate in TAGP during the extensions. The final two rows present a test for a trend over the entire period and the period that was covered by unlimited insurance. Both time periods show a positive and significant trend displaying that non-interest bearing accounts did become a greater fraction of total deposits over time. The trend is even larger and still statistically significant at a 1% level over the period of unlimited insurance. The decline in non-interest bearing accounts is discussed further in Appendix A. It is believed that companies with very large non-interest bearing deposits exited the extensions of the TAGP in an effort to save the increased fee that was required during the extensions because they knew that the unlimited insurance would return on December 31, Literature Review Firm structure, governance structure, and balance sheet items have been the main focus in recent cash holdings literature. The most extensive work has addressed balance sheet determinants and corporate cash holdings. Harford (1999) showed that cash-rich firms are more likely to make acquisitions and further finds that these acquisitions decrease firm value. Opler, et al. (1999) documented that firms with strong growth opportunities and riskier activities hold relatively more cash. They also found that large firms and those with 6

7 credit ratings tend to hold relatively less cash. Mikkelson and Partch (2003) showed that firms with cash holdings of more than 25% of their assets support growth and have a median operating performance that is greater than the performance of firms matched by size and industry, and thus found no evidence that large cash holdings inhibit firm performance. Bates, et al. (2009) documented that from , U.S. firms increased cash holdings. They found increases among firms that either did not pay dividends, were in more recent IPO listing cohorts, or were in industries that experience the greatest increase in idiosyncratic volatility. Reasons attributed to this build-up were fallen inventories, increased cash flow risk, decreased capital expenditures, and increased R&D expenditures. In December 2008, during the most recent financial crisis, Campello, et al. (2010) surveyed chief financial officers (CFOs) in 39 countries and found that financially constrained firms planned to cut more investment, technology, marketing, and employment relative to financially unconstrained firms. Furthermore, constrained firms had to use cash reserves and cut planned dividends during the crisis. Fresard (2010) provided a link between firms cash holdings and future market performance, finding that firms with large cash reserves are able to strategically position themselves at the expense of industry rivals. Brown and Petersen (2011) provided a strong link between R&D smoothing and cash holdings during the boom and the bust. To my knowledge, no one has directly examined the effect of FDIC insurance on corporate liquidity. Academic research on FDIC insurance has primarily examined the insufficient funding of the FDIC Bank Insurance Fund (Merton (1977), Marcus and Shaked (1984), and Kuritzkes, et al. (2005)). Pennacchi (2006) presented empirical evidence that banks have become better at managing liquidity shocks since the advent of FDIC insurance. In addition, he stated that the flight to bank deposits may be explained by the FDIC insurance. Pozar (2011) discussed the Dodd-Frank Act and the effect of institutional cash pools. He further discussed the increase in temporary unlimited insurance on non-interest bearing transactions and how companies were not expected to increase cash pools past levels held in July However, no empirical tests 7

8 are provided. Several papers have also examined the impacts of the liquidity programs during the most recent crisis; however, these do not examine the increase in FDIC insurance and cash holdings Hypotheses The goal of this paper is to show that an increase in coverage stemming from TAGP and DFA incentivized companies to hold on to cash. This leads to the hypotheses: Hypothesis 1: The initial TAGP Act led to banks experiencing an increase in non-interest bearing deposits. Therefore there should be a significant difference between the amount of funds held in noninterest bearing accounts at these banks and at banks that opted-out of the TAGP. Each extension of the TAGP and the passage of the DFA provided companies with the confidence that the insurance would last indefinitely. Around the time that each Act was announced or passed, a significant increase in non-interest bearing accounts and cash holdings should occur. Hypothesis 2: Significant breaks in both non-interest bearing accounts and corporate cash holdings around the passage of the Acts should be observed. Because data on the amount of corporate cash held at banks in the form of deposits is not available, dummy variables for the dates of the unlimited insurance are created in order to find the relationship between changes in cash holdings during the times of the TAGP and the DFA. Hypothesis 3: Cash holdings should be positively correlated with the dates when FDIC unlimited insurance was offered. The use of the dummy variables for the dates of the TAGP in the company analysis is not ideal, but does capture how cash holdings changed during the periods of unlimited insurance. In addition to the explanation in Hypothesis 3, I also expect that cash holdings should increase after the TAGP and the DFA were announced. This is because companies might start holding more cash in anticipation of the unlimited insurance. Hypothesis 4: Cash holdings should have increased during the announcement periods of the FDIC unlimited insurance. 6 See Christensen, et al. (2009), Stroebel and Taylor (2009), Wu (2011), and Duygan-Bump, et al. (forthcoming) 8

9 One concern is that these dates may overlap periods for changes in other important determinants of cash holdings. The only other determinants that have been analyzed in academic research that are not controlled for are recessions. The Great Recession, which lasted from December 2007 until June 2009, has been shown to have had an effect on cash holdings. Stone and Gup (2012) use historical recessionary dates to determine the changes in cash holdings during the previous five recessions and find that the actual dates of the recessions did not have as much of an effect as the dates of the announcement by the National Bureau of Economic Research (NBER). 7 During the announcement dates of recessions, a positive relationship is found, suggesting companies held more cash during recessions. While both of these overlap the periods of the TAGP, as well as the first and second extension of the TAGP, additional controls are added for recessions. Hypothesis 5: When controlling for recessions, the positive change in cash holdings should be present for both the periods of the unlimited insurance as well as the announcement periods. 5. Data To test Hypotheses 1 and 2, quarterly data from 2002 until 2012 were gathered from the FDIC website on non-interest bearing accounts and total deposits. I delete observations where total deposits are zero. 8 Since, the focus is on cash holdings located at firms in the United States, data on banks outside of the United States are deleted. 9 To test Hypothesis 1, individual bank data from all FDIC insured institutions is used. This provided a sample of 312,446 bank-quarter observations. To test Hypothesis 2, two measures were created: an aggregate measure of non-interest bearing accounts, which is created by summing the amount held in noninterest bearing accounts at all FDIC insured banks for a given quarter; and a ratio of non-interest bearing deposits to total deposits, which is created by summing across non-interest bearing accounts and total deposits for a given quarter. 7 The business cycle dates and announcement dates are reported by the NBER at 8 There are 101 observations. These are assumed to be mistakes due to non-zero amounts for non-interest bearing deposits. 9 The FDIC provides bank data on institutions located in the U.S. territories of American Samoa, Guam, Mariana Islands, Puerto Rico, and the Virgin Islands. These represent approximately 706 observations. Leaving them in the dataset does not affect the results. 9

10 To test Hypotheses 2, 3, 4, and 5, data were gathered on commonly used accounting determinants of cash holdings from Compustat Quarterly Files. To finish testing Hypothesis 2, an aggregate measure defined as the sum of cash holdings across all firms was created. The variables that have been chosen are in line with past literature such as in Opler, et al. (1999). Financial firms (SIC ) and utilities (SIC ) are excluded because financial firms hold cash related to their unique business practices and utilities hold cash for regulatory purposes. In addition to using all non-missing observations from Compustat from , two additional data sets are created to examine the changes in different types of firms. The data set of all firms in Compustat consists of 433,507 firm-quarter observations. Because companies in differing stages of the corporate life cycle might react to the unlimited insurance differently, two additional data sets were created to examine these differing relationships. All firms are sorted into deciles based on market-to-book ratios, and then the bottom three deciles are defined as mature firms. This consists of 130,017 firm-quarter observations during the period. The final data set consists of growth firms. A growth firm is defined as a firm whose sales revenue grows faster than the growth in Gross Domestic Product (GDP). 10 This consists of 171,156 firm-quarter observations from 1980 until The following describes the variables in the datasets: Cash holdings, the dependent variable in the Tobit regressions, is defined as cash and marketable securities divided by total assets. This measures the liquid assets available to the firm. Market-to-book ratio is measured as the market value per share to the stated book value of equity. It is used as a measure of growth opportunities that are available to a firm in the future. Cash flow is earnings after interest, taxes, and dividends divided by total assets. It measures the cash available to the firms after paying out normal expenditures associated with running the firm. Net working capital is measured as net working capital minus cash and cash equivalents divided by total assets. The standard definition of net working capital does not subtract cash. However, due to cash being the 10 As a robustness check, a growth firm is defined as a firm whose employees grow faster than the growth rate of the economy. The results were similar to the calculation using sales revenue. All growth rates are calculated on a one and fiveyear rolling basis. The results were similar and thus only the five-year results are presented. 10

11 variable of interest, the definition is modified, similar to prior literature. Net working capital is used as a measure for cash substitutes as some firms may be able to sell liquid assets instead of using cash holdings. Capital expenditure to assets is capital expenditure divided by total assets. This measures the future expected revenue growth for a firm. It is believed that cash holdings and capital expenditure will have opposite signs since firms can use cash reserves to fund future expansion. Leverage is long term debt plus current debt divided by total assets. Leverage measures the total debt that a company has taken on. This may be an alternative for cash holdings because some firms may be able to acquire more debt instead of using cash holdings. Research and development (R&D) to sales is R&D divided by sales and is also used as a measure of a firm s growth opportunities. However it measures the creative effort that a firm puts into growth instead of the market opportunities of growth. If R&D is missing in Compustat then it is set to zero. Acquisitions to Assets are acquisitions divided by total assets. Acquisitions are reported as zero if Compustat reports a missing value. This measures the growth opportunities that a firm has experienced through acquiring other companies. Dividend Dummy equals one if the company pays a dividend and zero otherwise. Dividend is defined as a common dividend (shares outstanding multiplied by cash dividend per share) plus the preferred dividend divided by the shares outstanding. Firms may increase their cash holdings by cutting a dividend that was being paid or by delaying a dividend. No dividend is recorded if Compustat reports the dividend as missing. Investment Grade Dummy is set equal to one if a company has a bond grade of BBB- or above, otherwise the dummy equals zero. The bond rating data comes from Compustat ratings database that contains the Standard & Poor s (S&P) long and short term corporate bond ratings. Bond ratings have been used in the previous literature to gauge whether a company has additional options when accessing funds. An investment grade dummy is included because a company that has an investment grade may have additional access to bond markets over non-investment grade companies. 11

12 Size is the natural log of a firm s total assets in 1984 dollars. The Consumer Price Index (CPI) is used to account for inflation and is obtained from the Bureau of Labor Statistics. Large firms have been shown by Opler, et al. (1999) to hold less cash because these firms have greater access to capital markets. Cash Flow Riskiness is the standard deviation of industry cash flows computed by the method suggested in Opler, et al. (1999). It is calculated as the standard deviation of cash flows for the previous five years, if available. These observations are then averaged across the two-digit SIC code. The measure of industry cash flows is employed because levels of cash flow can differ greatly across industries. TAGP Dummy is a dummy variable that equals one if the date of the quarterly report covers the original dates of the TAGP from October 14, 2008 until December 31, 2009 or zero otherwise. Extension TAGP Dummy is a dummy variable that equals one if the date of the quarterly report covers the original dates of the first extension of the TAGP from January 1, 2010 until June 30, 2010 or zero otherwise. Second Extension TAGP Dummy is a dummy variable that equals one if the date of the quarterly report falls within the time frame of the second extension of the TAGP from July 1, 2010 until December 31, 2010 or zero otherwise. DFA Dummy is a dummy variable that equals one if the quarterly report date falls within January 1, 2011 and December 31, 2012 or zero otherwise. 11 Table 2 contains the summary statistics on the accounting variables. The mean of cash holdings is suggesting that almost 15% of companies total assets are held in cash. In 23% of the firm-quarters a dividend is paid and 8.54% of all firm-quarters have an investment grade rating. The unlimited dummies represent the percentage of observations that are included in the unlimited time frame. A higher percentage of observations occur over the DFA because the DFA covered a longer time period than the TAGP and its extensions. However, approximately 12% of the observations are during the period of increased insurance. 11 The DFA began on December 31, 2010, the same day that the TAGP ended. The DFA Dummy does not include December 31, 2010 because that would include the entire quarter ending with December 31, 2010 of which the majority of the observations were included under the TAGP and not the DFA. 12

13 6. Econometric Models and Empirical Results A. Difference-in-Differences I first test whether the TAGP had an effect on non-interest bearing accounts when it was first enacted. The difference-in-differences (DiD) method is used to test this hypothesis. DiD measures the change induced by a particular treatment or event. In this case, the change in non-interest bearing transaction accounts after the October 13, 2008 passage of the TAGP is measured. It is expected that for banks that did not opt-out of TAGP and for dates after October 13, 2008 that non-interest bearing account balances should have increased. With DiD, there must be a control group and treatment group and a specific event that is being examined. Banks that opted-out of the TAGP make up the control group while the treatment group includes banks that participated. Thus, participated will be equal to one if the bank did not opt-out of the TAGP and zero otherwise. The TAGP was passed on October 13, 2008 so post2008 is a dummy variable equal to one if the Call Report date is after the passage of the TAGP and zero otherwise. These two variables are also interacted. The model is given by equation 1: non interest accounts it = α 0 + β 1 participated + β 2 post2008 +β 3 (participated post2008) + ε (1) where non interest accounts it is the amount of money in non-interest bearing accounts reported by bank i at time t. Participated is the dummy variable for participation in the TAGP, post2008 is whether the data falls within the range of the TAGP, and ε is the error term. In addition, I control for the bank age by using the Founding Age which is the date that the bank started operations or the Insured Age which is the date that the bank became insured by the FDIC. The need to control for firm age is that older, established banks might hold more deposits simply due to size and not because of the TAGP. Standards errors are clustered by bank certificate number, which is an identification number assigned to each bank by the FDIC. 13

14 I test two different datasets in the regression. The first is that containing all banks that opted-out of the program. To do this, banks that opt-out of the program are coded as non-participants from the time they opt-out until December 31, This allows banks that opt-out during the extensions to switch in the middle of the analysis. However, as noted earlier a large decline in deposits is seen during the extensions due to large banks not participating in the program and thus the banks opting out may drive the results. To control for this I only examine the period prior to the extensions. Thus, the banks that optedout of the initial TAGP are coded as non-participants and the sample does not change over the time period. Because the DFA applied to every bank, there is no control group, thus observations that occur past January 2011 are excluded. The data set consists of 312,446 bank-quarter observations from January 2002 until December The results from the DiD estimation are shown in Table 3. Panel A presents the entire time frame and Panel B excludes In Panel A, the three main variables are statistically significant at a 1% level. However, the interaction is negative and significant at a 1% level. This is not what is expected and thus drives the need to exclude the extension periods. Even when controlling for founding age in Column 2 and insured age in Column 3 the interaction remains negative and statistically significant. Thus, Panel A provides significant results that banks that participated in TAGP had a significant decrease in non-interest bearing accounts during the unlimited insurance period. When examining the results in Panel B, all three variables of interest are positive and statistically significant at a 1% level. Thus, during the original TAGP period banks that participated in the TAGP had a significant increase is non-interest bearing accounts. The results remain even when controlling for founding age and insured age. The coefficients for the age controls are both positive and statistically significant at a 1% level suggesting that older firms hold more non-interest bearing accounts. The results in Panel B suggest that banks did have an increase in non-interest bearing accounts and that the results in Panel A are driven by the firms that opt-ed out of the program. In unreported results, non-interest bearing deposits held at banks that opted-out of the program continued to increase during the exclusion periods. It is believed that this is why the results in Panel A are obtained. 14

15 It is expected that a further increase in non-interest bearing accounts occurred after the initial enactment of the TAGP. This is shown in Figure 1. Due to the uncertainty of whether the TAGP would be extended, companies might have been more hesitant to deposit cash initially. However, after the extensions were passed, companies increased deposits to take advantage of the unlimited insurance. This is examined empirically in the next section. B. Structural Breaks in Non-Interest Bearing Accounts and Corporate Cash Holdings The second test that is used is the Bai and Perron (2003) test for structural breaks to see if breaks in both non-interest bearing accounts and cash holdings occurred around the same time. Bai and Perron provide a test for multiple endogenous structural breaks in time series data and allow either the constant and the lag of the variable of interest to break, or just the constant. For the interest in this paper, only the constant is allowed to break. The Bai and Perron procedure allows one to choose the maximum number of breaks in which to test as well as the minimum length of each break. A maximum of seven breaks is allowed to occur. Seven breaks are chosen in order to allow one break to occur at the start and end of each period in which unlimited insurance is offered. Although a maximum of seven breaks are permitted to occur, there are occasions when the optimal number of breaks may be less than seven. In order to select the optimal number of breaks, the Bayesian information criterion (BIC) is used. In addition, a duration of at least two quarters is allowed for the break. Allowing a duration of two quarters provides an opportunity to test if both extensions of the TAGP had a significant effect on the series. The predicted breaks for both non-interest bearing accounts and cash holdings are presented in Table 4. The first two panels list the predicted break dates for the two measures of non-interest bearing accounts while the last two list the predicted break dates for the two measures of cash holdings. In Panel A, the BIC finds that the optimal number of break dates for the sum of non-interest bearing accounts is five and all five dates are around the period of unlimited insurance. The F-statistic is 9.67, which is statistically 15

16 significant at a 1% level. 12 The first break is in the second quarter of This is one quarter prior to the passage of TAGP but during a time when talks had begun about providing the unlimited insurance. The second break occurs during the second quarter of Panel A of Figure 1 shows a large increase in deposits lasting until the first quarter of 2011 followed by an even higher increase in deposits. Both of these dates are shown as break dates. The first increase is during the first extension of TAGP and the second is when the DFA took effect. The next predicted break is during the fourth quarter of This is during the DFA and shows a small decrease in the amount held in non-interest bearing accounts, possibly because of obligations due at the end of the year. The final break is during the second quarter of 2012 when an increase in non-interest bearing deposits occurs. Panel B lists the predicted breaks for the ratio of non-interest bearing deposits to total deposits. The BIC finds that the optimal number of breaks is seven. The F-statistic is 8.54, which is statistically significant at a 1% level. 13 There are four breaks that occur prior to the period of unlimited insurance. The fifth break occurs in the third quarter of 2010, which corresponds to an increase seen in Figure 1. This is in the middle of the first and second extensions of the TAGP. The next break occurs during the second quarter of 2011 indicated by an increase in the ratio followed by a sharp decrease. This is one quarter following the DFA. The second quarter of 2012 is where the final break occurs. Again, there is a noticeable increase in the ratio occurring two quarters prior to the expiration of the DFA. The breaks in the sum of cash holdings across firms is listed in Panel C. The BIC again finds that seven breaks are optimal. The F-statistic is 12.01, which is significant at a 1% level. For the corporate cash holdings series, a double break occurs in 2003 and a single break occurs in During this time, banks within holding companies began to allocate deposits in amounts less than $100,000 in order to circumvent the FDIC s $100,000 limit, yet still achieve full insurance (Pennacchi (2006)). In addition, the steady increase in the sum over time could be an artifact of Compustat increasing its coverage in firms throughout the years. The final four breaks occur during the unlimited insurance period. The first is 12 The critical value for the 99 th percentile is 7.85 for five breaks and one breaking parameter. 13 The critical value for the 99 th percentile is 6.75 for seven breaks and one breaking parameter. 16

17 during the fourth quarter of This is during the quarter in which the TAGP was passed. The next break is during the second quarter of 2009 when the FDIC was considering the first extension of the TAGP. The following break is in the second quarter of 2010, which is the quarter that both the announcement of the final extension of TAGP was announced and the DFA was passed. The final break is during the second quarter of 2012, which is when an increase in cash holdings is observed. The final measure of the ratio of cash and cash equivalents to total assets is presented in Panel D. The BIC finds that seven breaks is the optimal number of breaks. The F-statistic is 11.70, which is significant at a 1% level. Similar breaks are seen during the early and mid-2000 s as with the sum of cash. There are again three breaks found during the unlimited insurance periods. The first during the fourth quarter of 2008 was during the first quarter of the passage of TAGP. The second break during the second quarter of 2009 is prior to the announcement of the first extension of TAGP, but continues through the extension. The final break is during the third quarter of 2011, when a decrease in the ratio of cash to total assets is observed. While the decrease towards the end of the period could be due to an increase in total assets and not necessarily a decrease in cash, companies had less holdings of cash and cash equivalents. In summary, although a direct relationship between increases in cash held by corporations and noninterest bearing accounts cannot be made, evidence is provided that both increased during the periods of unlimited insurance and have similar break dates. C. Double Censored Tobit Model How did cash holdings change during the periods of unlimited insurance and the announcement of the unlimited insurance? If companies are holding more cash due to the unlimited insurance, cash holdings should increase and thus a positive relationship should be seen during the dates. To test this, the Tobit model with double censoring at zero and one is used. The dependent variable in all regressions is cash holdings and represents a fractional value, between and including zero and one. Similar to the model in Loudermilk (2007), I employ a random effects Tobit model. The lag of cash holdings for the prior three quarters is also included because quarterly data is being used and past quarterly cash holdings are likely to 17

18 influence cash holdings in future quarters. Loudermilk (2007) extends the Tobit model to accommodate both lagged dependent variables and random effects. Even though the model does support values at the corners, six dummy variables are included to control for these corner values: three dummy variables that are equal to one if each lag of cash holdings is equal to one and zero otherwise and three dummy variable for whether each of the three lags are equal to zero and zero otherwise. 14 Year dummies are also included in all regressions and standard errors are clustered at a company level. i. Enactment Dates of Unlimited Insurance The first test is for a change in cash holdings during the enactment dates of the unlimited insurance acts. The results using the enactment dates of the unlimited insurance periods are presented in Table 5. The results from all firms in Compustat with non-missing observations are displayed in Column 1. Column 2 contains the results using the mature firm data set and Column 3 presents the results using the growth firm data set. The variables of interest are the four dummy variables shown at the bottom of the table. For all firms, the relationship between cash holdings and TAGP dummy is positive and significant, suggesting that cash holdings increased during the TAGP period of unlimited insurance. This is also true for both extension TAGP dummy and second extension TAGP dummy. The coefficient on TAGP dummy is only slightly larger than the coefficient for both the extensions, suggesting that this initial increase in cash persisted over each subsequent extension. The coefficient on DFA dummy is positive and significant for all firms suggesting that firms continued to increase cash holdings during the period of the DFA. The coefficient on DFA dummy is as large as the extension TAGP dummy, suggesting that firms continued to increase cash by just as much during the DFA. This was discussed for non-interest bearing accounts that firms continued to increase cash held in non-interest bearing accounts even during the quarter preceding the expiration of the DFA. 14 The coefficients on the corner control dummies are not included but are available upon request. In the majority of regressions, all coefficients are negative and significant at conventional levels. 18

19 The second column contains the results from isolating the mature firms. During TAGP an increase in cash holdings is observed. This increase in cash holdings during the TAGP is significant at a 1% level. The results found when looking at the extension TAGP dummy show that cash holdings decreased during this time for mature firms. This is significant at a 10% level, but the coefficient (.00352) represents only a third of a decrease from the initial increase during TAGP. The second extension TAGP dummy and DFA dummy have a negative sign but the results are not statistically different from zero. Thus, mature firms seem to have increased cash holdings during TAGP, then decrease cash holdings slightly, but maintained similar levels of cash holdings during the duration of the TAGP and the DFA. Results for the growth firms are found in Column 3. Results for growth firms are similar to the results for all firms. An increase in cash holdings is seen during the TAGP, the first and second extension of the TAGP, and the DFA. The increase during the first and second extension of the TAGP and the DFA is larger than the increase for all firms. However, as I discuss in Section 7, this result for growth firms could be due to the changing economy and the recession. Thus, firms could have been holdings cash for precautionary reasons due to worsening economic conditions. A brief look at the control variables shows results consistent with prior papers. The relationship between cash flow and cash holdings is positive and significant at a 1% level indicating that firms with higher cash flows hold more cash. In addition, the relationship between each net working capital, capital expenditures to assets, acquisitions to assets, and cash holdings is negative and statistically significant at a 1% level indicating that firms that have larger net working capital, more capital expenditures, and experience acquisitions hold less cash. R&D to sales has a positive and statistically significant relationship with cash holdings suggesting that firms that have more R&D expense hold more cash. One interesting result, and one for which I have no explanation, is that size has a positive relationship with cash holdings in Columns 1 and 3. Opler, et al. (1999) showed that larger firms hold less cash. 19

20 ii. Announced Dates In addition to testing for how cash holdings changed over the enactment of the unlimited insurance Acts, it is of interest to examine how cash holdings changed over the announcement dates of the Acts. Most of the announcements came well before the Acts took effect and it is of interest to see if using these dates provides evidence that corporations increased cash holdings knowing the unlimited insurance would be extended. All regressions in Table 5 are re-estimated using the dates that the Acts were announced. The idea is that firms, knowing that unlimited insurance might be extended, started saving more cash when an extension announcement was made. The TAGP was enacted on October 13, The first extension was announced August 26, 2009 and the second extension was announced June 22, The date the DFA was passed, July 21, 2010 is used in all regressions as the enactment date. Thus announced TAGP dummy is a dummy variable equal to one if the quarterly report falls within the days that the TAGP was announced and the next announcement date and zero otherwise. Announced extension TAGP dummy is a dummy variable equal to one if the quarterly report falls within the days that the first extension of the TAGP was announced and the next extension was announced and zero otherwise. Finally, announced DFA dummy is a dummy variable equal to one if the quarterly report falls within the days of the announcement of the second extension of the TAGP and the DFA and the expiration of the DFA. Notice that separate dummy variables for the second extension of the TAGP and the DFA are not included. This is because the announcements were made a month apart in the second quarter of The results can be found in Table 6. Again, Column 1 presents the results from the entire sample of firms, Column 2 the results using the mature sample, and Column 3 the results using the growth sample. When looking at the entire sample, notice that all three announcement dummies are positive and statistically significant at a 1% level. This suggests that cash holdings increased over these periods. The coefficient increases over the three dummies suggesting that more cash was saved during each extension of the unlimited insurance. The mature firm results show that cash holdings increased over all three periods. Whereas Table 5 showed no relationship between cash holdings and both extension of TAGP and DFA, by including the 20

21 announcement dates all variables have a positive and significant relationship that increases with each subsequent announcement. The increase in cash holdings during every period is statistically significant at a 1% level. Finally, growth firms have a positive increase in cash holdings across all three dummies, and again all three are statistically significant at a 1% level. The coefficient on announced TAGP and the announced extension of TAGP are both large and of similar magnitude. In summary, the data reveals that when using both the enactment dates of the unlimited insurance and the announcement dates of the unlimited insurance, a significant increase in cash holdings is seen across all firms, as well as both mature and growth firms. However, these results could be driven by deteriorating economic conditions. Thus, in the next section I test for an increase in cash holdings while controlling for recessionary variables. 7. Robustness Check Thus far, a relationship between the periods of unlimited insurance and cash holdings has been shown. However, the increased insurance did occur over the time of the Great Recession. Thus, as a robustness check, control variables for macroeconomic conditions are included. Almeida, et al. (2004) showed that constrained firms cash holdings increase when cash flows are higher. Therefore, the sensitivity of cash is positive. They are able to relate this to business cycles and found that constrained firms increase their holdings of cash following negative macroeconomic shocks. 15 Ferreira, et al. (2005) examined business conditions as a determinant of firms cash holdings and found evidence that cash levels increase during recessions, especially for financially constrained firms. Baum, et al. (2006) employed a GARCH model and used macroeconomic aggregates to show that over time there is variation in a firm s cashto-assets ratio. They also documented that a doubling of uncertainty in the economy leads from an 8% to a 40% reduction in the dispersion of the cash-to-assets ratio. Duchin, et al. (2010) studied the 2007 financial crisis and documented that corporate investment decline was greatest for firms that have low cash reserves, 15 Almeida, et al. (2004) measure macroeconomic shocks as the log of real GDP and three of its lags. 21

22 are financially constrained, or operate in industries dependent on external finance. They also found that cash had an insignificant effect from July 2008 to March 2009 due to firms financial power evolving as the crisis lengthened. Stone and Gup (2012) find that the announcement dates of recessions are significant in determining corporate cash holdings. Six additional macroeconomic variables are included that have been shown to change during recessions. The NBER defines a recession as a significant decline visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. 16 Thus, the civilian-employment to population ratio, real personal income, industrial production index, and GDP Gap are included. 17 It is expected that during economic turmoil all variables would decline. 18 In addition, the term spread, defined as the difference between the ten-year and one-year Treasury Constant Maturity Rate, and the default spread, defined as the difference between Moody s Aaa corporate bond yield and Moody s Baa corporate bond yield are included. All macroeconomic variables and their components are obtained from the Federal Reserve Economic Data (FRED). The term spread and default spread are included because it has been shown that each is correlated with recessions. Fama and French (1989) find that the term spread displays business cycle patterns. Wheelock and Wohar (2009) provide a literature survey of the term spread and its predictive power with output growth and recessions across several countries. Chen (1991) confirms that the default spread is negatively correlated with output growth. A. Including Recession Indicators and Unlimited Insurance Dates Table 7 displays the results from including the macroeconomic variables into the regressions with the dates of the enactment of the TAGP, first and second extension of the TAGP, and DFA. Column 1 reports the results for the entire sample of firms. The coefficients have changed substantially from the results in Table 5. TAGP dummy is still positive and statistically significant at a 1% level indicating that cash 16 NBER US Business Cycles Expansion and Contractions 17 GDP Gap is defined as the difference in real GDP and real potential GDP. 18 When it is suggested that a decline in GDP Gap would occur it is implied that the GDP Gap would become negative and this value would decline further. 22

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