Letter number 135 of January 2021

  • NEW

News : How large listed European groups invest their cash balances in a negative interest rate environment By Márton Járosi and Luca Palermo

We are pleased to publish an article by Márton Járosi and Luca Palermo, summarizing their HEC Paris Msc thesis they have written under our supervision.

Corporate finance literature and education is largely focused on valuing projects and businesses based on their cash flows, but rarely if ever is residual cash, and what is done with it when it stays in the firm addressed. While we do certainly recognize the vast amounts of research on the topic of corporate cash balances, such as Almeida & Campello (2010)[1], Campello et al. (2011)[2] and Lins et al. (2010)[3], just to name a few, we must also highlight that with the exception of Duchin et al. (2017)[4], most academic papers are focused on the size of corporate cash balances/financial asset portfolios and do not precisely address what is done with these resources. In our study, conducted through 15 hour-long interviews with CFOs and corporate treasurers of listed, large and mid-sized European groups, we endeavored to address the topic of cash management and its evolution with the emergence of low/negative interest rates from a practitioner’s point of view and shed some light on the above-mentioned coverage gaps. The following pages represent a brief summary of the key insights obtained, which must be read keeping in mind that any survey based study cannot escape the key concerns of: 1) questions may be misunderstood, 2) respondents may not be entirely truthful and/or complete in their answers, 3) respondents may not be representative of the broader set of corporations.

Inspired by Duchin et al. (2017), who went as far as describing investment activity of US industrial firms as “[…] an unregulated asset management industry of more than $1.5 trillion, questioning the traditional boundaries of nonfinancial firms.”, we thought it necessary to first establish the set of assets our interviewees considered within the scope of their treasury role. One respondent was not willing to disclose the detail of investment products they consider, leaving us with a set of 14.

Unsurprisingly, all 14 interviewees hold some of their cash balances in bank/current accounts, with one emphasizing the current superiority of standard bank accounts to money market funds that yield negative interest rates by stating that in their experience, banks in France would not apply negative interest rates to accounts, as long as the amount is limited to €50 million.

In addition, 12 of our 14 respondents invest in term deposits at banks, although there are some differences in terms of maturity and liquidity preferences. One group limit themselves to only investing in term deposits with a maximum maturity of 3-months, while another emphasized that they require 32-day liquidity for all their deposits, when technically they are for a longer term. Additionally, another group of respondents stated that they invested in a mix of different maturity term deposits, but never would consider a term longer than 1 year.

Money market funds fall within the scope of 10 respondents, naturally limited to a 1-year maturity. These products clearly lost popularity in the post crisis era of falling and negative short-term interest rates, which induced significant cash outflows, a key finding which will be described more in detail below. Within the money market fund universe, one respondent mentioned a strong internal push to invest 100% in “green funds”, but at the same time lamented a lack of available/eligible funds to be able to do so, within their counterparty risk and maximum fund exposure limits. While our study is certainly not dedicated to the emergence of ESG investing, it is quite interesting to see that not only are institutional investors and asset managers concerned about the issue, corporates also consider it to some degree in their cash management policy.

Moving on to less popular cash investment products, we found that 5 of the 14 interviewees stated to invest in Commercial Paper (CP) and Certificates of Deposit (CD), while only 4 respondents stated to consider direct investments in government debt. Interestingly, when CP is considered, most companies did accompany that with a rating limitation to such investments, consistent with the idea of “not increasing the risk of the company through cash management”.

In addition to the above “traditional” corporate cash management products, we further found some residual asset categories that are considered by corporate treasurers, albeit only 1 or 2 of our interviewees. These go as far as equities, FX swaps, 3-party repos, derivatives, insurance products and private equity.


Having established the relevant asset universe, we can move on to the key findings of our study. Regarding cash policies, motivations, objectives and how these change with the emergence of a low/negative interest rate environment, one predominant conclusion can be drawn: there is no clear-cut, standard way of practicing and thinking about treasury management. Our interview experiences clearly shed light on the fact that many, if not all, cash policy aspects differ on a company-by-company basis, even on the main question of how negative interest rates affect investment policies, where half of our respondents claimed it had no effect and the other half stating the opposite. Nevertheless, we did manage to identify some generally agreed upon behaviors and beliefs, as well as important factors explaining differences in policy.

The first commonly held belief is that negative interest rates were a psychological challenge for all market participants. It is very difficult for CFOs and corporate treasurers to accept that cash can yield negative returns and this reluctance drives most of our respondents’ investment behavior, highlighted by one respondent calling it “initially counterintuitive” to pay to make a deposit. One would assume that this effect is even more pronounced with treasurers who have been in the field for a long time and thus remember the higher interest rate environment, but due to the nature of the people we spoke to being in senior positions, we do not have that contrast in our sample and can thus only make educated guesses. Extending this psychological issue beyond the heads of corporate decision makers, one interviewee stated that there had been a 2-year lag between negative central bank interest rates and bank account rates. This means, that for 2-years, it had not been commercially acceptable for banks to make clients pay for cash. While it should not come as a surprise that negative interest rates were a challenge for bankers too, it is interesting that this psychological barrier did affect actual market practices for a relatively long period of time, allowing corporates to benefit from positive rates, when they should technically not have been able to.

Another commonality identified in the majority of our respondents is that yield does matter when making cash management decisions, even if many interviewees claimed that it does not, when initially asked. The significance of yield materializes as one of the money market fund selection criteria, even if subordinated to other concerns around liquidity, security, counterparty risk, exposure limits and diversification. One respondent neatly summarized the above by stating “When you stick to cash & equivalents you can’t do magic, but of course within constraints you look for the best yield”. This becomes even more evident when taking the negative interest rate environment into consideration, where many CFOs and corporate treasurers expressed their intention of doing “damage control in terms of yield” and stating that “cash has to not cost anything”. Considering all of the above we believe it is fair to say that the avoidance of negative interest rates on cash balances is a key consideration for the vast majority of corporate treasurers.

The intention to avoid negative interest rates has led to the third commonality we identified: the general shift of corporate cash balances from money market funds and low bank account balances into maximizing current accounts and term deposits. With that in mind, some respondents highlighted the importance of increasing the amount of banking counterparties to achieve 2 objectives simultaneously: 1) avoid being charged negative interest rates on deposits exceeding a certain balance limit, 2) control exposure to any one individual counterparty. One interviewee recalled the challenges of this internal shift by stating that it required a complete flip of the internal cash management IT system.

The fourth and last common theme we were able to identify is the idea that low/negative interest rates are not necessarily detrimental to corporates, as they are borrowers first and cash investors second, with some respondents even admitting to partially playing the CP to money market fund spread, by issuing CP at -50bps and investing that money at around -30bps in money market funds, thus earning 20bps (numbers for illustrative purposes only).

In addition to the above 4 trends and broadly held beliefs, we were able to gain some interesting insights into what firm characteristics and other factors play a key role in determining a particular company’s cash management policy.

First of all, company size and along with it, the amount of available cash resources matters a lot. Larger companies tend to be able to dedicate more resources to their treasury department and as a result are able to think of cash in a much more granular way. As a result, there is more scope for active “asset management”, which expresses itself through a more diverse cash investment universe and yield being more of a factor in investment decisions. In addition, large corporates more frequently distinguish between operational and excess cash and were more likely to change their cash policy as interest rates were lowered.

Secondly, ownership structure, in particular the level of family control over a certain company, affects how its cash management is done. Family-owned businesses tend to have a larger “safety cushion” and more excess cash. Furthermore, such companies are particularly reluctant to accept negative interest rates on cash investments and, naturally, are less frequently pressured on treasury policy by their shareholders.

Lastly, we want to highlight two often overlooked factors, the first one being that relationships matter. The ease with which credit facilities are set-up, drawn and extended critically depends on the personal relationships between the treasury department of the corporate and their core banks. What is more, current account interest rates are often simply used as bargaining chips in this constant give and take between the two parties. Finally, and in relation to the above, it must be mentioned as a key finding of our study, that human factors remain important in treasury policy, as in fact they do in most if not all aspects of the economy. No story better illustrates this than the one we were told about a CEO who was not able to buy painkillers in the early days of the Covid19 pandemic, who therefore – in fear of a similar situation regarding his company’s liquidity –, instructed his CFO to draw on their existing credit facilities.



[1] “Financing Frictions and the Substitution between Internal and External Funds”, by Heitor Almeida and Murillo Campello, Journal of Financial and Quantitative analysis, Vol. 45, No. 3, June 2010

[2] “Liquidity Management and Corporate Investment During a Financial Crisis”, by Murillo Campello, Erasmo Giambona, John R. Graham and Campbell R. Harvey, The Review of Financial Studies, Vol. 24, No. 6, June 2011

[3] What drives corporate liquidity? An international survey of cash holdings and lines of credit”, by Karl V. Lins, Henri Servaes and Peter Tufano, Journal of Financial Economics 98, 2010

[4] “Precautionary Savings with Risky Assets: When Cash is not Cash”, by Ran Duchin, Thomas Gilbert, Jarrad Harford and Christopher Hrdlicka, The Journal of The American Finance Association, Vol. 72, No. 2, April 2017


Statistics : Corporate capital raising has reached an all-time high in 2020

Originally published by the daily newspaper Les Echos, with Refinitiv as its source, this graph clearly shows the big difference between the 2008 crisis of financial origin and that of 2020.

The former resulted in a 25% contraction in corporate fundraising (and in fact much greater because it was concentrated in the last quarter), with a strong rebound (+78%) in 2009 when investors came out of their self-imposed confinement and once again played their part.

In 2020, central bank liquidity injections reassured investors, pushing them towards corporate securities that were more remunerative than those of governments. And as the memory of the 2008 liquidity crisis had not faded from the minds of financial directors, groups massively issued securities, first debt, then equity for those who felt they needed it.

As a postscript, let us remind our dazed reader, who would be surprised that debt issues are structurally much higher than equity issues, that this is due to the fact that debts are repaid sooner or later, often by issuing new debts, whereas equity is perpetual (unless it is reduced by losses). Löwenbräu's balance sheet still shows the equity contributed by its shareholders at its foundation in 1383, whereas the debts contracted have long since been repaid and replaced by others!

Research : The effect of activist funds on the financial and social performance of companies

With the collaboration of Simon Gueguen, lecturer-researcher at CY Cergy Paris University


The spectacular growth of activist funds over the past twenty years is the source of profound changes in corporate governance and value creation strategies. While they only take minority stakes in the capital of their targets, these funds manage to impose changes in operations strategy or financing policy. Academic research has been interested in the impact of their actions, especially since the publication in 2008 of an article[1] showing a very positive immediate effect on the value of a target of an activist's entry into its capital. Several studies have confirmed this immediate effect, but activist funds have also been accused of being short-term, or of creating shareholder value to the detriment of other stakeholders. The article we present this month[2] offers an empirical analysis including short-and long-term financial performance and social performance of the companies targeted by activists. The results point to short-term financial performance achieved at the expense of the long-term financial and social performance.

The empirical study is based on a sample of more than 1,000 activist campaigns on the US market between 2000 and 2016. Regarding the market value, Desjardine et al use as an indicator the Tobin Q ratio (ratio of the market value of assets to their replacement value, estimated by the net book value). They see a 7.66% rise in market value the year the activist takes over, which is comparable to previous studies on the subject. On the other hand, they observe a drop of 4.92%, then 9.71% in the fourth and fifth years. This result contrasts with a study published in 2015[3], which found that the increase in market value observed at the time of entry into the capital was retained over the long term. The 2015 study sample covered another period (1994 to 2007), and above all Bebchuk et al used stock market performance and not the Q ratio to measure value creation.

With regard to return on assets, Desjardine et al observe a slight increase in the first two years, followed by a sharp drop between the second and the fifth years. Finally, the operating cash flow of targeted companies decreases in the first year, and the decrease becomes economically significant after two years. These results are spectacular because they show not only a short-term effect of activist intervention (short-term gains corrected for the long term), but also a negative long-term net effect. However, they do not directly relate to the market performance of the targets, and part of the observed effects may be linked to structural changes (in particular, asset disposals) often imposed by activists.

For the same sample, Desjardine et al measure a sharp reduction in spending by the targeted companies, confirming the tendency of activist funds to impose a policy of cost reduction. Over the five years following the arrival of the fund, the number of employees, operating expenses, research and development expenses and capital investments decrease significantly. Overall, targeted companies invest more than others (all things being equal) before the activist fund arrives, and less in subsequent years. The social and environmental performance of targets is also significantly poorer after the arrival of funds.

The empirical study is supplemented by qualitative discussions based on interviews with specialists, fund managers and executives of targeted companies. Two main elements stand out. First, the tendency of activist funds to discount future cash flows at higher rates than other shareholders, resulting in a strong preference for fast cash flows. Then, the pressure felt by the managers of the targeted companies may encourage them to prioritise short-term financial performance, to the detriment of social performance, or even employee security.

By proposing, based on a single sample, a comprehensive analysis of the effects on targets of activist funds taking a stake in their capital, the article offers a critical vision of activism based on the existence of short-term consideration for performance obtained by funds. The article thus contributes to academic literature that is developing on this subject, with sometimes contradictory conclusions. A theme to which we will return soon in this newsletter.


[1] A. Brav, W. Jiang, F. Partnoy and R. Thomas, "Hedge fund activism, corporate governance, and firm performance", Journal of Finance, vol. 63(4), 2008, p. 1729 à 1775.

[2] M.R. Desjardine and R. Durand, "Disentangling the effects of hedge fund activism on firm financial and social performance", Strategic Management Journal, vol.41(6), 2020, p. 1054 à 1082.

[3] L.A. Bebchuk, A. Brav, W. Jiang, "The long-term effects of hedge fund activism", Columbia Law Review, vol. 115, 2015, p. 1085 à 1155.


Q&A : How does the cost of equity materialise?

Let’s start with an analogy. Are you currently aware that you need air to live? Most of the time not, because we don't think about it. Now that this question has been asked, you realize that if you stop breathing, you are condemned to die.

Well, the cost of equity capital is a bit the same thing. Most of the time, everything is fine, and companies don't realize that it exists because they respect it, satisfy it, almost without realizing it the way you breathe, and that we live like this, automatically, without realizing it.

Note that, in finance, a cost it is not necessarily just an accounting charge like financial interests, or a cash outlay like a dividend. For example, when the Russian state decides to adopt governance and compliance rules similar to those in Western Europe, the share price of Russian companies will rise and their cost of capital will fall. This poor governance in Russia, both in the public and private domain, does not translate into a flow or an accounting cost, yet it does have an impact on value. It is the same for the cost of equity capital. Part of it, or even all of it for a company that does not distribute dividends, is expressed other than as a cash outlay.

To simplify, take a company that does not pay dividends, such as a start-up. It does, however, have a very real cost of equity, which is materialised by the fact that its shareholders expect a certain progression in its operational performance (developing a prototype, passing a threshold of 1,000 customers, then a million, etc.). Without this progression, the investors will not invest fresh new equity to cover its losses and the start-up will end up, like 70% of them, disappearing 10 years after their creation. 

Now take a company like Google that doesn't pay dividends but is no longer a start-up. How does its cost of equity materialise? In the same way as before, through an expected improvement in its operating performance, which this time materialises in positive free cash flow. Failing to obtain them in the medium term, investors would sell their Google shares and the share price would fall. At some point, the board of directors would then change management to implement a new policy; otherwise a hostile takeover would occur. This is what happened for example to ABN Amro after years of disappointing performance. The group was bought out and torn apart.

 It's a bit like when you ride a bike, when you stop pedalling, you fall off.  Here, it's the same thing, if you don't respect on the medium term the profitability demands of the investors, they will stop financing you, they will want to change the management to continue to bring funds.

Even if the company is controlled, it is not safe from investors who make their voices heard and who force a change of strategy: think for example of Casino which, under pressure from activist shareholders, had to sell off assets to reduce and restructure its debt which was suffocating it because of poor operational performance.

In a nutshell, the cost of equity for any company is thus materialised by an imperative of profitability, without which shareholders would lose the confidence they have in management, impose constraints or directions, and be less inclined to provide funds when necessary, which would of course be detrimental to the company's growth prospects.


New : Comments posted on Facebook

Regularly on the Vernimmen.com Facebook page[1] we publish comments on financial news that we deem to be of interest, publish a question and its answer or quote of financial interest.

Here are 3 questions and answers on financial analysis topics

In a company valuation, should shareholders’ short-term loans be reintegrated into shareholders' equity or assimilated to net debts?

As a general rule, they are considered for what they are, i.e., a loan from the shareholders. You would only consider them as equity if there was a firm and irrevocable commitment by the shareholders to convert them into share capital. In this case, you would take into account the number of additional shares to be issued in the total number of shares of the company to be consistent.

In the calculation of return on equity, the numerator subtracts exceptional charges from net income, but not in shareholders' equity in the denominator, which includes the net income impacted by exceptional charges. Isn't it an aberration to remove non-recurring items from the numerator and not from the denominator?

We don't think so: the capital gain generated is not part of the company's current, recurring income, so it should be removed from net income in the numerator. On the other hand, once the shareholders have decided not to pay the capital gain as a dividend and therefore to reinvest it in the company, regardless of its legal or accounting qualification, it has become equity capital on which it is normal to expect a certain rate of return as on the rest of the equity capital. So in the denominator, there is no reason to deduct it.

How to conduct the financial analysis of a holding company?

The financial analysis of a pure holding company is of little interest unless it is indebted to banks or the financial market.

Indeed, the notion of margin does not exist because there are no sales, investments excluding financial fixed assets are non-existent, as is the working capital. As for returns, it is biased, because possible dividends only reflect part of the profitability of portfolio companies, and capital gains are rarely regular every year.

The only point of interest, if the holding company is indebted, and it is crucial then, is to study carefully how the holding company can repay this indebtedness through dividends received, disposal of assets, capital increase to be subscribed by the shareholders of the holding company if they can.