Readers of this blog are familiar with the “short-termism” position: Because of the rise in shareholder power, the marginal use of funds for many corporations is no longer fixed investment, but increased payouts in the form of dividends and sharebuybacks. We’re already seeing some backlash against this view; I expect we’ll be seeing lots more.
The claim on the other side is that increased payouts from established corporations are nothing to worry about, because they increase the funds available to newer firms and sectors. We are trying to explore the evidence on this empirically. In a previous post, I asked if the shareholder revolution had been followed by an increase in the share of smaller, newer firms. I concluded that it didn’t look like it. Now, in this post and the following one, we’ll look at things by industry.
In that earlier post, I focused on publicly traded corporations. I know some people don’t like this — new companies, after all, aren’t going to be publicly traded. Of course in an ideal world we would not limit this kind of analysis to public traded firms. But for the moment, this is where the data is; by their nature, publicly traded corporations are much more transparent than other kinds of businesses, so for a lot of questions that’s where you have to go. (Maybe one day I’ll get funding to purchase access to firm-level financial data for nontraded firms; but even then I doubt it would be possible to do the sort of historical analysis I’m interested in.) Anyway, it seems unlikely that the behavior of privately held corporations is radically different from publicly traded one; I have a hard time imagining a set of institutions that reliably channel funds to smaller, newer firms but stop working entirely as soon as they are listed on a stock market. And I’m getting a bit impatient with people who seem to use the possibility that things might look totally different in the part of the economy that’s hard to see, as an excuse for ignoring what’s happening in the parts we do see.
Besides, the magnitudes don’t work. Publicly traded corporations continue to account for the bulk of economic activity in the US. For example, we can compare the total assets of the nonfinancial corporate sector, including closely held corporations, with the total assets of publicly traded firms listed in the Compustat database. Over the past decade, the latter number is consistently around 90 percent of the former. Other comparisons will give somewhat different values, but no matter how you measure, the majority of corporations in the US are going to be publicly traded. Anyway, for better or worse, I’m again looking at publicly-traded firms here.
In the simplest version of the capital-reallocation story, payouts from old, declining industries are, thanks to the magic of the capital markets, used to fund investment in new, technology-intensive industries. So the obvious question is, has there in fact been a shift in investment from the old smokestack industries to the newer high-tech ones?
One problem is defining investment. The accounting rules followed by American businesses generally allow an expense to be capitalized only when it is associated with a tangible asset. R&D spending, in particular, must be treated as a current cost. The BEA, however, has since 2013 treated R&D spending, along with other forms of intellectual property production, as a form of investment. R&D does have investment-like properties; arguably it’s the most relevant form of investment for some technology-intensive sectors. But the problem with redefining investment this way is that it creates inconsistencies with the data reported by individual companies, and with other aggregate data. For one thing, if R&D is capitalized rather than expensed, then profits have to be increased by the same amount. And then some assumptions have to be made about the depreciation rate of intellectual property, resulting in a pseudo asset in the aggregate statistics that is not reported on any company’s books. I’m not sure what the best solution is. [1]
Fortunately, companies do report R&D as a separate component of expenses, so it is possible to use either definition of investment with firm-level data from Compustat. The following figure shows the share of total corporate investment, under each definition, of a group of six high-tech industries: drugs; computers; communications equipment; medical equipment; scientific equipment other electronic goods; and software and data processing. [2]
As you can see, R&D spending is very important for these industries; for the past 20 years, it has consistently exceed investment spending as traditionally defined. Using the older, narrow definition, these industries account for no greater share of investment in the US than they did 50 years ago; with R&D included, their share of total investment has more than doubled. But both measures show the high-tech share of investment peaking in the late 1990s; for the past 15 years, it has steadily declined.
Obviously, this doesn’t tell us anything about why investment has stalled in these industries since the end of the tech boom. But it does at least suggest some problems with a simple story in which financial markets reallocate capital from old industries to newer ones.
The next figure breaks out the industries within the high-tech group. Here we’re looking at the broad measure of investment, which incudes R&D.
As you can see, the decline in high-tech investment is consistent across the high-tech sectors. While the exact timing varies, in the 1980s and 1990s all of these sectors saw a rising share of investment; in the past 15 years, none have. [3] So we can safely say: In the universe of publicly traded corporations, the sectors we think would benefit from reallocation of capital were indeed investing heavily in the decades before 2000; but since then, they have not been. The decline in investment spending in the pharmaceutical industry — which, again, includes R&D spending on new drugs — is especially striking.
Where has investment been growing, then? Here:
The red lines show broad and narrow investment for oil and gas and related industries — SICs 101-138, 291-299, and 492. Either way you measure investment, the increase over the past 15 years has dwarfed that in any other industry. Note that oil and gas, unlike the high-tech industries, is less R&D-intensive than the corporate sector as a whole. Looking only at plant and equipment, fossil fuels account for 40 percent of total corporate investment; by this measure, in some recent years, investment here has exceeded that of all manufacturing together. With R&D included, by contrast, fossil fuels account for “only” a third of US investment.
In the next post, I’ll look at the other key financial flows — cashflow from operations, shareholder payouts, and borrowing — for the tech industries, compared with corporations in general. As we’ll see, while at one point payouts were lower in these industries than elsewhere, over the past 15 years they have increased even faster than for publicly traded corporations as a whole. In the meantime:
Very few of the people talking about the dynamic way American financial markets reallocate capital have, I suspect, a clear idea of the actual reallocation that is taking place. Save for another time the question of whether this huge growth in fossil fuel extraction is a good thing for the United States or the world. (Spoiler: It’s very bad.) I think it’s hard to argue with a straight face that shareholder payouts at Apple or GE are what’s funding fracking in North Dakota.
[1] This seems to be part of a larger phenomenon of the official statistical agencies being pulled into the orbit of economic theory and away from business accounting practices. It seems to me that allowing the official statistics to drift away from the statistics actually used by households and businesses creates all kinds of problems.
[2] Specifically, it is SICs 83, 357, 366, 367, 382, 384, and 737. I took this specific definition from Brown, Fazzari and Petersen. It seems to be standard in the literature.
[3] Since you are probably wondering: About two-thirds of that spike in software investment around 1970 is IBM, with Xerox and Unisys accounting for most of the rest.
Oil and gas is a pretty high-tech industry. The investment boom was partly about new fracking and deep-sea technologies that could tap previously inaccessible deposits. And new scientific methods of finding them.
Of course you are right. Still, this isn’t what most people have in mind when they talk about financial markets reallocating capital to new sectors.
“I think it’s hard to argue with a straight face that shareholder payouts at Apple or GE are what’s funding fracking in North Dakota.”
Why do you say that? I disagree strongly with that view. On a macro basis, those shareholder payouts are going to shareholders who either spend the money on consumption or re-invest it somewhere.
If the latter, some amount of those dollars find their way to other companies via bond issuance or equity issuance. Saying that it’s spent to buy existing shares or bonds from other investors still doesn’t resolve the question of ultimate use of those dollars – for every buyer, there has to be a seller.
It has been well-publicized that the small and mid-cap E&P sector has been, on an aggregate net basis, investing amounts in excess of operating cash flow for the past several years. That implies, on a net basis, raising money from the debt and equity markets. The investors who are buying those issues are, broadly speaking, the same ones active across the markets as recipients of dividends (and interest) and sellers of securities.
In the simplest form it could be, say Calpers using dividends to buy part of a primary bond issue or stock offering. In most cases, though, the I’d expect the path is indirect.
You’re right, I shouldn’t be dismissing in an aside what is, actually, the key issue in this whole debate. My only defense is that this post is just one installment in an ongoing project.
I do not, in fact, believe that money paid out to shareholders must result in either higher consumption or higher real investment. The result can also be lower aggregate income. (This is the fundamental insight of Keynes.) It’s also possible — I would say certain — that a substantial fraction of payouts result in higher incomes within the financial sector, rather than increased funding for some other nonfinancial firm. I don’t think we can answer this question deductively, we have to look at the concrete channels by which increased payouts in one set of firms might relax financial constraints on another.
t has been well-publicized that the small and mid-cap E&P sector has been, on an aggregate net basis, investing amounts in excess of operating cash flow for the past several years. That implies, on a net basis, raising money from the debt and equity markets.
You’re right, this is what we should be looking for. I will explore this. I doubt the amount of funds being raised by the kinds of firms you’re talking about is quantitatively significant. But if it is, great! — I’ll have learned something.
In the simplest form it could be, say Calpers using dividends to buy part of a primary bond issue or stock offering. In most cases, though, the I’d expect the path is indirect.
Right, the simplest case is the real thing. But you need a concrete story about the indirect route. We don’t live in a loanable funds world, it is not the case that “the money has to go somewhere.”
More generally on Dave T’s theme, does it really matter if a lot of companies are sending their money back to shareholders? Does that really imply that that money is no longer available for productive investment?
The money doesn’t just stop with the shareholders, does it? We don’t live in a Tolkien economy where whenever the dragon gets a piece of gold he just sits on it and doesn’t let the dwarves use any of it. The shareholders get the dividends and then send them right back out the door, either by buying stuff or putting it in the bank where it is loaned out again. Why wouldn’t an appropriate share of it then find its way back into productive investment?
According to the Surowiecki New Yorker piece you linked to, direct measures of corporate R and D spending are higher than ever, and plenty of investors are taking very long positions in tech companies that don’t issue dividends, so the economy seems to be doing fine as far as long-term productive investment goes. What do you make of his argument?
I’m not sure the indirect way you are analyzing this issue is the best, or that it makes sense to be so picky about what constitutes the high-tech sector. New hydrocarbon drilling techniques are not blue-sky stuff, not like the shrink-ray in Ant-man, but they are technologically progressive and have had a huge impact on the economy–bad for the climate but good for energy prices, living standards and growth. (The rent guidelines board in NYC issued its first ever no-increase rent guidelines largely because of the drop in heating-fuel prices.) Isn’t this kind of a textbook example of capital being productively invested?
As I’ve mentioned on Tim Worstall’s article commenting on this post, the macro is (as usual, IMO) refuted by correctly analysing the micro.
Why are companies giving capital back to shareholders? Because a greater degree of gearing is generally desired by investors.
Why is that? Because interest rates are low, and because the amounts people are allowed to borrow for their mortgages are limited to multiples of household income that are totally outdated.
Given that typical domestic investors are prevented from taking on a reasonable degree of risk in buying their home, it’s hardly surprising that they’re looking to gain some risk by buying shares in more highly geared companies.
As to fracked oil and gas, the well deplete so rapidly that (with the largest production gone in 3 years and all in 5 years) that it requires repeated drilling of new replacement wells, often 2 or more, to make up for the “lost” production. And certainly NG wells have been running below the costs of production since 2012 and running on debt (partly subsidized by the Fed) and fumes ever since. I read somewhere recently that the Saudis had drilled just a few hunndred wells in the last year, the Russians some 8000 and the U.S. some 80,000. SO the returns both physically in EROEI and financially are quite low. Increased investment, in an environment relatively low in alternative investment prospects and with low rates encouraging the “reach for yield” is not exactly a “virtuous” cycle, but rather a sign of decreasing “marginal efficiency of capital.
But I would like J.W. to expand a bit more on this point:
“I do not, in fact, believe that money paid out to shareholders must result in either higher consumption or higher real investment. The result can also be lower aggregate income. (This is the fundamental insight of Keynes.)”
Obviously the key word their is “real” investment, which might not be unambiguously definable. But I take it the alternative is financial investment in asset price inflation, which would shift the distribution of income, along with the level of leverage in the system, without, relatively speaking, increasing “real” investment in productivity-enhancing projects, resulting in less “real” investment spending and corresponding wage-based consumption demand. Is that the sorts of channels responsible for lowered aggregate income? Yes, the money (and, though to a lesser degree, credit creation) has to go somewhere, but the issue is the relative productive efficiency of allocation mechanisms, not just where the money is parked.
I assume that the number of listed companies in these sectors would have changed quite a bit over these years as well (more software companies formed and listed in recent years for example). does that affect the analysis as well? share of investment of high tech industries in total investment should automatically get affected if number of high tech companies has changed over time versus change in total number of companies.
Well sure. Investment in the high-tech sectors can increase either due to more investment at the same companies, or an increase in the number of companies. For purposes of the discussion here, I don’t see that it makes much difference whether growth is taking place on the intensive or extensive margin.