The persistence and pricing of changes in multinational firms' foreign cash holdings

Using a hand-collected sample of U.S. multinational firms' foreign and domestic cash holdings, we evaluate the earnings persistence implications of changes in foreign and domestic cash and whether stock prices reflect these implications. Building on the earnings decomposition approach in Dechow, Richardson, and Sloan 2008 Journal of Accounting Research, 46 (3): 537-566, we find that, in the overall sample, changes in foreign cash are as persistent for future earnings as changes in domestic cash. In the cross-section, we find that foreign cash changes have higher persistence when foreign operations offer better growth opportunities and when repatriation taxes are lower. We then examine whether investors correctly price the persistence implications of foreign and domestic cash changes. We find a positive association between current foreign cash changes and one-year-ahead stock returns, suggesting that investors underreact to foreign cash changes or equivalently underestimate the earnings persistence of foreign cash changes. We further document that investors are more likely to misprice foreign cash changes when information processing costs are higher and when firms have poorer information environments. Our study sheds light on a recent paper by Harford, Wang, and Zhang 2017 The Review of Financial Studies 30 (5): 1490-1538, who find that investors discount foreign cash changes, which they attribute to agency costs and investment inefficiencies. Our findings suggest that the discount is more likely due to investor mispricing of foreign cash changes.