Are companies still playing it too safe with cash?

NEW YORK -- Still smarting from the rough days, companies may be playing it too safe in their determination to pay off debt and build up cash.

Though stock dividends have enjoyed a rebirth, driven by last year's tax cut and shareholder demand for more certain investment returns, there are record amounts of cash sloshing around in corporate coffers, waiting to be put to better use.

What's a "better" use? The answer surely varies by company. It can mean paying higher dividends, buying back stock and bonds, or investments in the future such as product development and expansion.

But it doesn't mean sitting on more cash than a company may reasonably expect to need to make ends meet on rainy days. While companies earn a bit more interest on their cash than the paltry yield on a savings account or money market fund, that's not considered a very productive use of the most precious resource in the world of corporate finance, where idle money is seen as sin rather than virtue.

It's only natural that corporate executives might remain a bit trigger shy amid an uneven recovery from the harrowing downturn of the financial markets and the economy in 2001 and 2002.

More recently, they have loosened the purse strings some for dividends and buybacks. But business investment remains very hesitant, and so the overall stash of corporate cash is growing to record levels which many observers consider exceedingly cautious.

On the one hand, dividend payouts and buybacks have risen sharply in 2003 and 2004. Among the major corporations in the Standard & Poor's 500 stock index, 376 companies are slated to distribute a record $183 billion in dividends during 2004, up from $148 billion in 2002 paid out by an all-time low 351 companies.

However, dividend payouts remain somewhat anemic by several yardsticks, and a substantial chunk of the buybacks will merely offset the flood of new shares from employees exercising their stock options.

This year's dividends represent only about a third of 2004's estimated profits for the S&P 500, well below the long-term trend. Since 1936, the S&P 500 have paid out an average of slightly more than half their reported profits as dividends,

More glaringly, the 373 non-financial companies in the S&P 500 now have more than $550 billion in cash and easily liquidated investments, up from $440 billion at the end of 2002 and $260 billion at the end of 1999, according to S&P analyst Howard Silverblatt. (Financial companies are excluded because a great deal of their available cash can be viewed more as an "inventory" of the main product in their business dealings.)

The cash horde contradicts a basic tenet of corporate finance:

If it's not being reinvested in a manner that can improve shareholder value at a rate better than the risk-free return of a Treasury security, cash should be returned to equity investors, either through dividends or share buybacks.

Even if investors may not get a better return on their own, the thinking goes that it should be their option whether to put the excess cash into other stocks, bonds, or a new motorcycle.

If anything, many companies are still focusing more on debt reduction, buying back bonds rather than allocating the cash to dividends or stock buybacks.

Although the unbridled optimism a few years back left many companies hobbled with debt, borrowing remains an essential element of healthy investment and business growth. That's why, when the market collapsed and the economy entered recession, the Federal Reserve cut interest rates to stimulate the borrowing.

But despite the lowest borrowing costs in decades, companies seem more determined to build a cash cushion to impress the market rather than investing in the business or rewarding shareholders directly.

"Don't get us wrong. Debt reductions beat the heck out of the crazy 'synergistic,' transformational deals we saw during the bubble days," Henry H. McVey, chief U.S. strategist for Morgan Stanley & Co., wrote in a recent report calling for companies to boost dividends and buybacks if they won't put their cash to work.

He is not, however, optimistic that executives will heed that call. Once again, part of the problem may derive from divergent interests between management and investors, stoked by a familiar culprit - stock options

"Corporate America now appears to have something of an incentive 'malfunction.' Dividends lower the value of existing options, which is how most CEOs and their boards pay themselves. Barring a major change in current incentive structures, we just do not see the dividend floodgates opening."