expanding. indeed, former federal reserve board chairman alan greenspan pointed to this unusual configuration a year and a half ago. " although capital investment has been advancing at a reasonably good pace, " he said, " it has nonetheless lagged the exceptional rise in profits and internal cash flow. " subsequently, aggregate cash holdings remained elevated through much of last year, even as the economy continued to advance smartly. only in the very recent quarters has this trend seemed to abate somewhat. we are left with an overall picture of a highly liquid corporate sector - perhaps more like that which we would expect of corporate balance sheets in the early stages of an expansion. as policymakers and forecasters, we might ask why corporations have built up such a large stock of liquid assets. is the buildup of cash indicative of a " new equilibrium "? is there something about the current economic or regulatory environment that requires the maintenance of high liquidity levels? and, does the current level of liquidity portend a more robust surge in corporate spending? partial explanations for large holdings of cash almost by definition, the rise and fall in cash holdings can be linked to fluctuations of operating cash flows and capital expenditures. a simple regression of changes in cash, on changes in operating cash flows, and on changes in capital expenditures - using annual data from 1957 to 2001 - accounts reasonably well for historical fluctuations in cash at u. s. nonfinancial corporations, with a regression r - squared of over 50 percent. however, in this framework, the current period appears to be an outlier. 4 that is, even after factoring in the current - cycle dynamics of strong profit growth and relatively modest investment, a good part of the rise in liquid assets remains unaccounted for - as much as one half of the total rise in cash - to - assets - according to federal reserve staff estimates. a number of explanations have been advanced for this unusual rise, and they have a bearing on judging whether this is a temporary shift born of the current environment or a result of a persistent change in behavior. foreign operations the first explanation relates to the growing significance of foreign operations of u. s. multinationals in countries with lower corporate tax rates and the recent accumulation of earnings retained by the foreign subsidiaries. when u. s. multinationals receive dividends from their foreign subsidiaries and the host country levies a lower tax rate than the u. s. corporate tax rate, any repatriated dividends are subject to u. s

percent of business fixed investment. another leading hypothesis is that businesses were more risk - averse than warranted by the underlying economic fundamentals, especially early in the expansion. one obvious source of caution was the degree of conviction about the strength and sustainability of the recovery. concerns about terrorism and other geopolitical uncertainties were likely at play as well. although many periods of recovery are accompanied by concerns of economic growth and political turmoil, surveys in 2002 and 2003 suggested that business leaders were experiencing a more prolonged sense of gloom, with measures of sentiment dropping to low levels for as long two years beyond the trough in the business cycle. since the spring of 2003, however, the economy has been expanding briskly and thus the durability of the recovery should be a less significant constraint on capital expenditures now. indeed, more recently, some surveys of business confidence and capital spending plans have reached or exceeded the levels of the late 1990s. nonetheless, concerns about global political uncertainties often reemerge in executive suites and board rooms as important factors for business spending plans. regulatory environment still, one corollary of the corporate - caution explanation may have persisted. many have argued that the conditions created by the corporate governance scandals - and the regulatory response to those events - have contributed to a more cautious attitude toward risk taking. more concretely, the scandals themselves, and the markets ’ reaction to them, are said to have caused firms to restrain capital spending. clearly, sarbanes - oxley compliance costs have been substantial, diverting funds and, probably even more importantly, some of the attention of chief executive officers ( ceos ) and boards of directors from capital spending and r & d plans. every meeting that board members and executives spend focused predominantly on compliance issues is, by definition, meeting time generally not being spent on big strategic questions. however, proving the connection between executives ’ " mind - share " and capital expenditure rates is difficult. moreover, firms are benefiting to some degree from reforms arising from sarbanes - oxley. thus, research on the net effects of sarbanes - oxley being undertaken by aei and other institutions should be exceptionally useful as the economic, political, and legal environment continues to evolve. based on the evidence available to date, i believe that the uncertainty resulting from the regulatory and legal environment has had meaningful economic implications for business investment and cash holdings. catalysts for change each of these factors - increased foreign operations, greater investor focus on liquidity, business caution due