Putting theory into practice: why is a cash-rich firm such as Apple using the bond markets?

Author:Berry, Robert

In crude terms, financial theories claim to emphasise key ideas that recur in different situations while ignoring the contextual details. In fact, this separation rarely happens--traces of the time and place in which the theories are developed are embedded in the way they are stated. Also, since theory testing involves data drawn from a specific time and place, more contextual information inevitably gets mixed in with key ideas during testing. As a result, the theories on offer to financial managers combine ideas and contexts in an ad-hoc way.

Financial managers who want to put financial theories to use therefore have a tricky task. They must strip out the remnants of the contexts in which these concepts were developed and tested to get back to the underlying ideas. Only then can the theories be put to work in the particular situations the managers are facing. The effective use of financial theory is based on the recognition that the same core ideas can lead to different conclusions in different settings.

Let's consider a problem that's currently bothering Apple's management team. Over the past couple of years the computing giant has faced pressure to find cash to increase dividend payments to shareholders. Pecking-order theory seems to offer Apple, and many other companies facing a similar need to bridge a funding gap, clear guidance on how to proceed (1).

The theory that is usually presented describes the sequence in which funding sources should be accessed. Cutting dividends (which is not relevant in Apple's case anyway) is ignored as a potential source of finance. This means that squeezing cash out of the company's existing assets and operations comes first in the sequence, with new debt next, followed by additional hybrid securities and, lastly, new equity.

Apple has a cash balance of about $140bn. So, according to pecking-order theory, its best course of action is obvious: run down this balance before even considering any other measure. Yet the firm has gone to the bond markets, raising substantial amounts of cash, which have been passed on to shareholders through dividend payments and stock repurchases. The cash balance remains untouched. This example doesn't seem to support pecking-order theory as either a predictive mechanism or a source of advice. If Apple's managers are aware of the theory--and they probably are--then why aren't they acting as the theory says they should?

This apparent conflict between theory and practice...

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