It’s well known that some basic parameters of the economy changed around 1980, in a mutation that’s often called neoliberalism or financialization. Here’s one piece of that shift that doesn’t get talked about much, but might be relevant to our current predicament.
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| Source: Flow of Funds |
The blue line shows the after-tax profits of nonfinancial corporations. The dotted red line shows dividend payments by those same corporations, and the solid red line shows total payout to shareholders, that is dividends plus net share repurchases. All three are expressed as a share of trend GDP. The thing to look at it is the relationship between the blue line and the solid red one.
In the pre-neoliberal era, up until 1980 or so, nonfinancial businesses paid out about 40 percent of their profits to shareholders. But in most of the years since 1980, they’ve paid out more than all of them. In 2006, for example, nonfinancial corporations had after-tax earnings of $800 billion, and paid out $365 billion in dividends and $565 in net stock repurchases. In 2007, earnings were $750 billion, dividends were $480 billion, and net stock repurchases were $790 billion. (Yes, net stock repurchases exceeded after-tax profits.) In 2008 it was $600, $470, and $340 billion. And so on. [1]
It was a common trope in accounts of the housing bubble that greedy or shortsighted homeowners were extracting equity from their houses with second mortgages or cash-out refinancings to pay for extra consumption. What nobody mentioned was that the rentier class had been doing this longer, and on a much larger scale, to the country’s productive enterprises. At the top of every boom in the neoliberal era, there’s been a massive round of stock buybacks, which you could think of as shareholders cashing out their bubble wealth. It’s a bit like the homeowners “using their houses as ATMs” during the 2000s. The difference, of course, is that if you took too much equity out of your house in the bubble, you’re the one stuck with the mortgage payments today. Whereas when shareholders use businesses as ATMs, those businesses’ workers and customers get to share the pain.
One way of thinking about this increase in the share of profits flowing out of the firm, is in terms of changing relations between managers and the owning class. The managerial capitalism of Galbraith or Berle and Means, with firms pursuing a variety of objectives and “owners” just one constituency among many, really existed, but only in the decades after World War II. That, anyway, is the argument of Dumenil and Levy’s Crisis of Neoliberalism. In the postwar period,
corporations were managed with concerns, such as investment and technical change, significantly distinct from the creation of “shareholder value.” Managers enjoyed relative freedom to act vis-a-vis owners, with a considerable share of profits retained within the firm for the purpose of investment. … Neoliberalism put an end to this autonomy because it implied a containment of capitalist interests, and established a new compromise at the top of the social hierarchies… during the 1980s, the disciplinary aspect of the new relationship between the capitalist and the managerial classes was dominant… after 2000, managers had become a pillar of Finance.
When I’ve heard Dumenil talk about this development, he calls the new configuration at the top a “loving marriage”; the book says, less evocatively, that today
income patterns suggest that a process of “hybridization” or merger is underway. … The boundary between high-ranking managers and the capitalist classes is blurred.
The key thing is that at one point, large businesses really were run by people who, while autocratic within the firm and often vicious in defense of their privileges, really did identify with the particular businesses they managed and focused their energy on their survival and growth, and even on the sheer disinterested desire to do their kind of business well. You can find a few businesses that are still run like this — I’ve been meaning to write a post on Steve Jobs — but by far the dominant ethos among managers today is that a business exists only to enrich its shareholders, including, of course, senior managers themselves. Which they have done very successfully, as the graph above (or a look at the world outside) shows.
In terms of the specific process by which this cam about, the best guide is chapter 6 of Doug Henwood’s Wall Street (available for free download here.) [2] As Doug makes clear, the increased payouts to shareholders didn’t just happen. They’re the result of a conscious, deliberate effort by owners of financial assets to reassert their claims on corporate income, using the carrot of high pay and stock for mangers and the stick of hostile takeovers for those who didn’t come through. Here’s Michael Jensen spelling out the problem from finance’s point of view:
Conflicts of interest between shareholders and managers over payout policies are especially severe when the organization generates substantial cashflow. The problem is how to motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inefficiencies [by which Jensen seems to have mostly meant high wages].
Peter Rona, also quoted in Wall Street, expresses the same thought but in a decidedly less finance-friendly way: Shareholders “take pretty much the same view of the corporation as a praying mantis does of her mate.”
You don’t see the overt Jensen-type arguments as much now that management at most firms is happy to disgorge all of its cash and then some. But they’re not gone. A while back I saw a column in the business press — wish I could remember where — expressing outrage at Apple’s huge cash reserves. Because they should be investing that in new technology, or expanding production and hiring people? Of course not. It’s outrageous because that’s the shareholders’ money, and why isn’t Apple handing it over immediately. More than that, why doesn’t Apple issue a bunch of bonds, as much as the market will take, and pay the proceeds out to the shareholders too? From the point of view of the creatures on Wall Street, a company that prioritizes its long-term growth and survival is stealing from them.
UPDATE: Ah, here’s the piece I was thinking of: Forget iPad, it’s time for iGetsomemoneyback. From right before the iPad launch, it’s a gem of the rentier mindset, complete with mockery of Apple for investing in this silly tablet thing instead of just handing all its money to Wall Street.
Why is Apple hoarding its cash? A company spokesman explains: “We have maintained our cash and strong balance sheet to preserve the flexibility to make strategic investments and/or acquisitions.” … Steve Jobs really doesn’t need an acquisitions warchest of around $30 billion … He should start handing back this money to stockholders through dividends. … The money belongs to stockholders: Give. Indeed Jobs should go further. Apple should — gasp — start borrowing, and hand that money back, too.
SECOND UPDATE: Welcome to visitors from Dealbreaker, Felix Salmon and Powerline. If you like this, other posts here you might like include Selfish Masters, Selfless Servants; The Financial Crisis and the Recession; What Do Bosses Want?; and in sort of a different vein, Satisfaction.
[1] There’s something very odd going on in the fourth quarter of 2005: According to the Flow of Funds, dividend payments by nonfinancial firms dropped to essentially zero. The shortfall was made up in the preceding and following quarters. I suspect there must be some tax change involved. Does anybody (Bruce Wilder, maybe) have any idea what it is?
[2] John Smithin’s Macroeconomic Policy and the Future of Capitalism is also very good on this; it’s subtitle (“the revenge of the rentiers”) gives a better flavor of the argument than the bland title.
Excellent post – my take on it is that the macro-stabilisation of the neo-liberal era and the Greenspan put leads to a focus on less risky process innovation + efficiency seeking rather than uncertain disruptive product innovation. This exacerbates the investment deficit and makes the surplus larger which can be doled out to stockholders.
I also think the problem is not the alignment of the stockholders and managers. Its the interaction of this phenomenon with the distinctly stabilised environment where financialisation is a source of rents from the Fed's commitment to prevent even a small deflationary episode.
The healthy situation above would require a regular influx of new entrants who invest far more than their profits and an occasional collapse of an incumbent thanks to this competitive pressure.
I wrote a post on tangential matters recently here http://www.macroresilience.com/2011/10/03/macroeconomic-stabilisation-and-financialisation-in-the-real-economy/
Hi Ashwin.
Glad you liked the post. You're writing some great stuff at Macroresilience.
In this case, though, I'm not sure I see things quite the same way you do. From where I'm sitting, the problem is that the hurdle rate for new projects seems to be much higher under neoliberalism than it was in the postwar system. Presumably because the higher payout rates mean firms have to rely more on external finance which is inherently costlier, and because management is on a shorter leash from financial claimants and has a harder time justifying risky projects. I'm not sure this is any less of a problem with respect to new firms than existing ones. If anything, the pressure to produce large returns quickly is probably even more intense for young firms that are more dependent on outside capital — just look at Groupon and the huge amount of cash it's already funneling to early investors.
More broadly, I certainly agree with you that our current "socialism for capitalists, capitalism for everyone else" arrangement is the worst of both worlds. But I'm not sure it's feasible or even desirable to get to capitalism for capitalists and socialism for the rest of us. To me, the more natural way forward is the one Keynes suggested — divorce decisions about investment from the pursuit of profit, somewhat like in the Golden Age, but much more fully and permanently.
Something seems a little fishy about that graph. When the solid line is below the dotted line, that means that stock repurchases must be negative – does that mean that corporations are issuing new stock to the market more than others are repurchasing? If so, why is that difference so positive during the tech boom of the late 90s, when everyone and their dog (pets.com) was going IPO, and corporations were planning more and more ways to attract all the loose cash running around the market (e.g., the Lucent spin-off from AT&T in 1996), and then shrinking to near-zero following the crash of 2000-2002 when the IPO market all but dried up?
Yup, that's what it means. Surprising but true: Even in the late 90s, the one recent period when firms did raise significant capital through stock offerings, repurchases still exceeded new issues. It's given as "net new equity issues" in the Flow of Funds — F.102, line 39.
The explanation, I think, is that while it is true that there are more IPOs in booms, there is also more cashflow, which firms are under pressure to distribute to shareholders via repurchases. The latter effect outweighs the former.
JW,
During the dotcom boom, free cash flow was actually quite weak. Firms actually levered up but continued to make stock purchases.
Also, keep in mind that the flow of funds data include nonlisted private firms. The proliferation of LBOs and private equity during the past two decades has also contributed to leveraging up and "negative equity issuance." In short, leverage was used to make payouts to equity holders.
Srini
Srini,
On the first point, you're right that cashflow peaked in mid 1997, while firms continued making large stock repurchases through mid-2001. I don't think that changes the story in any important way.
On the second point, again, you are certainly right that firms have borrowed to finance stock repurchases. Indeed, nonfinancial corporate business (NFCB) borrowing from credit markets over the past decade matches net equity repurchases almost exactly. If you regress NFCB borrowing on NFCB net equity issues for the period 2005-2010 you'll get a coefficient not significantly diff erent from -1, with an r-squared of 0.98. It's really an extraordinarily close fit. But again, the fact that businesses are borrowing in order to make bigger payouts to shareholders is in line with the argument of this post — it's just what the dude in the final quote is saying they should do.
JW – Thanks! Glad you like my posts. Like your take on this blog as well – There's a lot of interesting work to be done in investigating the structural dynamics of our current problems.
I get your point – this is exactly the dynamic that Minsky found so disturbing and made him suggest that we need to socialise investment just as Keynes wanted to. I agree almost completely with Minsky except IMO small debt deflations and market disruptions need to be allowed to prevent firms from levering up, introducing some risk of failure etc.
There are a few problems with going back to the Golden Age – for one, the financial system we had back then was just a stroke of good luck and is irretrievable as Minsky recognised. Too much "innovation" has happened and the Fed's control of money supply has essentially vanished. Moreover, it was a system of "order for all" which only worked due to the global dominance of the American industrial sector. Alex Field's book on the Depression also mentions the slowdown in manufacturing TFP post WW2 and I'm particularly fond of Burton Klein's much-unread books 'Dynamic Economics' and 'Prices, Wages and Business Cycles' which lay the blame for the 70s on this slowdown.
Obviously just my opinion but my take is that the neo-liberal era preserved order for the capitalists but introduced disorder for everyone else i.e. crony capitalism. To keep growth up, the entire economy but esp the consumer levers up in the absence of wage growth. And now we're here – the end of the line.
Sorry, I tried to post this comment yesterday but I had problems with the connection. Anyway:
The link to "Macroeconomic Policy and the Future of Capitalism" seems wrong.
Also, a rather uninformed comment:
Your argument that shareholders did "cash out" of non-financial businesses implies that there was a fall in non-financial investiment.
Where did that money go?
There are, IMHO, three options:
a) shareolders used the cash for consumption;
b) shareholders invested the cash in financial assets;
c) shareholders invested the cash in non-american assets.
a) seems unrealistic, although that cash could actually end up in financial assets that are supposed to be used for consumption (such as pension funds).
c) also seems unrealistic to me.
This leaves (b). So, why did shareholders disinvest from "real" business to invest in "financial" business?
I read often that the real level of life of most american households didn't increase much since the late seventies.
This implies that the "aggregate demand" also didn't increase that much. Thus, reinvesting profits in "real" business, whithout being able to sell the increased production, seems stupid.
On the other hand, investing in financial assets seems smarter, because while creditors retain their capital in form of credit, and also have profits (interest) from it, the same capital is used by the debtor and ends up as increased consumption.
This dinamic implies that the total of debts has to grow indefinitely, or else a "Minsky moment" happens when the marginal debtor is no more able to pay the due interest. However, "monetaristic" policies rely on lowering the interest rate to spur growth, thus delaying the Minsky moment, until it is no more possible to lower the interest rate because it is already 0.
RL-
Thanks, link fixed. (The book seems to be out of print, which is too bad.)
On the substantive point, I'm not sure why you consider (a) unrealistic. The consumption share shifted up by a bout five percent of GDP under neoliberalism, and it seems likely (tho I haven't looked at this specifically) that a large part of that increase represents consumption out of profit income. Of course the other part of it is an increase in debt-financed consumption by lower income households, as you say.
(c) is more than unrealistic; for it to be possible in the aggregate, the US would need a current-account surplus.
Of course the other thing that could happen in principle, and that the advocates for making firms disgorge cash claimed would happen in practice, is that the higher payouts simply allow finance to reallocate capital between firms and industries. As Jensen said (again quoting from Wall Street), "Wall Street can allocate capital among competing businesses and monitor and discipline management more effectively than the CEO and headquarters staff of the typical diversified company. KKR's New York offices … are direct a substitute for corporate headquarters in Akron and Peoria." In theory, the large outflows from nonfinancial businesses to asset-owners should be matched by equal flows back to other nonfinancial businesses, presumably mostly as debt. So the same share of cashflow is invested, but more of it passes through the financial system rather than following a path through a single firm. The idea is that Wall Street is both better able to identify profitable investments than people more directly engaged in production (odd — but you can find this idea in Keynes too, and then formalized as Tobin's Q) and, probably more importantly, having to depend on Wall Street for finance will force managers to apply stricter criteria of profitability to new projects.
On a purely logical level, that makes a kind of sense. The problem is that raising firms' required rate of return on investment doesn't increase the return on the projects available to them. It just shifts the investment function downward. All else equal, this reduces effective demand and leads the economy to a lower output (or higher unemployment and excess capacity) equilibrium. This is one explanation for why under neoliberalism it doesn't seem to be possible to get to full employment without asset bubbles, which temporarily push down the cost of capital and raise ex ante expected returns over what can be realized ex post
"(c) is more than unrealistic; for it to be possible in the aggregate, the US would need a current-account surplus."
This misses a key wrinkle. Basically, the Bushevik tax cuts exchanged a tax obligation for a bond obligation, which the U.S. investor class then sold abroad to foreigners, (not least those surplus nations acccumulating excess FX reserves), effectively borrowing long and cheap, to invest in FDI and equities abroad. In 2006, the U.S. Net International Investment Position, the official measure of the external debt attaching to the U.S. economy, stood at just south of $2.6 trillion, which was amazing since it was actually shrinking, even as U.S. CA deficits were rising to record levels, and if one added up all the CA deficits since 1990, $2.9 trillion was "missing" from the N.I.I.P. I discussed this with Brad Setser at the time and he agreed that the main reason was the boom in foreign equity markets, compared to the relatively lackluster U.S. equity market. The N.I.I.P. stood at $3.4 trillion in 2008, the last figure I found.
"
On a purely logical level, that makes a kind of sense. The problem is that raising firms' required rate of return on investment doesn't increase the return on the projects available to them. It just shifts the investment function downward. All else equal, this reduces effective demand and leads the economy to a lower output (or higher unemployment and excess capacity) equilibrium. This is one explanation for why under neoliberalism it doesn't seem to be possible to get to full employment without asset bubbles, which temporarily push down the cost of capital and raise ex ante expected returns over what can be realized ex post."
Yes, that sounds exactly right. To add on a few comments to the OP, buy-backs supposedly increase the capital gains available to investors by reducing the supply and thus raising the price of shares. But that only is realized if the investor sells-back. As opposed to dividends being paid out pari passu as was "originally" supposed to happen to ROI less retained earnings. This seems to me to indicate that it is very much a "play" for insiders to cash-out, a result of the perverse incentives of solving the supposed agent-principal problem by paying C-levels with shares and options, which means that management increasingly become owners of the company, aligned with their financier buddies, at the expense of other much more diffuse shareholders, (which are often "institutional" investors, controlled by financial "professionals" anyway). And borrowing for buy-backs, of course, increases the operating leverage of the firm, making it both less able to withstand economic stresses and more averse to long-run fixed capital investment project with high upfront costs. The hurdle rate of the NPV calculation will seems that much less enticing, given both the ease of cashing-out current productive asset "value' now and the increased claims on future income with the increased debt-load. In the meantime, rather than profits passing back into the market, where it can be re-invested or consumed, it goes to the fees and interest payments of the financiers…, which income then can be used for further "plays" to further leverage the market, goosing while extracting "value". It's really not all that different from what happens when I-banks arrange the privatization of public "assets", often enough in cahoots with the politicians they back. It's just the vaunted efficiency of "free markets" at work… constructing a toll-booth economy.
"On the substantive point, I'm not sure why you consider (a) unrealistic."
Well, this is a sort of preconception of mine, however this is my logic:
a) IMHO most people base their consumptions on their habits, that are determined on long term expected cash flows.
b) for most people, long term expected cash flow is based on wage. Very few people can have a long term expected cash flow from financial profits.
c) those people whose long term expected cash flow is based mostly on financial profits have, almost by definition, a lot of financial assets.
d) but people who have really a lot of financial assets are likely not to "burn" their principal, and in fact to try to increase it, because they both realize that their principal is the source of their cash flows and are likely to be very "thrifty" (or lse they would not have a principal to begin with).
This leaves out people who have a lot of wealth in financial or semifinancial assets (such as houses or pension funds) but see that wealth as "savings" instead than "principal" (or capital).
jch-
I'll have to think about your first paragraph a bit more but my first reaction is that you're overcomplicating things. US purchases of foreign assets must, as a matter of accounting, sum to foreign purchases of US assets, plus the US trade balance, plus net income flows. Tax changes can't affect that identity. Now, you might say that the increase in federal borrowing during the 2000s increased foreign demand for US assets because foreign investors, especially central banks, want safe liquid dollar assets in particular. (I would agree, and say that was a good thing. It's a matter for another post, but I think the Bush-era deficits were stabilziing rather than destabilizing, and that we'd be better off today if they'd been even larger. Of course we'd be also be better off if they'd been used to finance expanded social insurance and investment in public goods, but that's separate from the macroeconomic question.) But none of that has anything to do with the division of corporate surplus between retained earnings and payouts to shareholders. The "missing" amount from the NIIP simply reflects the fact that the US gets a higher return on its foreign assets than foreign holders get on US assets. A very interesting and important issue, but again, not related to the question here.
that only is realized if the investor sells-back. As opposed to dividends being paid out pari passu
Yes. William Lazonick makes a big deal about this. I'm not convinced it matters that much, though. It may be simplest to think of buybacks and dividends as basically equivalent.
borrowing for buy-backs, of course, increases the operating leverage of the firm, making it both less able to withstand economic stresses and more averse to long-run fixed capital investment project with high upfront costs.
Yes. In the Jensenist view, that's a feature, not a bug.
RL-
I basically agree with you. But there is a notion of wealth effects, which I don't think is completely unfounded.
On the other hand, the main channel for increased consumption relative to income may well be borrowing further down the income to scale to make up for stagnant wages. In that case, the link with higher payouts would be that rentiers, dissatisfied with the profits available from productive enterprises, turned to consumer lending — what Costas Lapavitsas calls financial expropriation.
IMO small debt deflations and market disruptions need to be allowed to prevent firms from levering up, introducing some risk of failure etc.
I need to go back and read your posts developing this argument, but I admit I'm having trouble accepting it. To me, it sounds a bit too much like saying that an effective fire department has led to people leaving their stoves on and not maintaining their wiring, so we need to occasionally let some houses burn down.
testing
The comments system is awful here, isn't it? Need to get off blogspot. Meantime, if your comment is long did you try splitting it in two?
JW:
The first part of my remark was in response to your response to R.L. cited, not the OP, but any way…
I might have erred in starting rhetorically with the Bushevik tax cuts, since it's a much longer running tendency of the emergent Wall St./MNC neoliberal regime than just that. It just struck me as a particularly "good" example of how the conjoined tendencies of globalization and financialization work.
But the CA deficit consists in the trade deficit + "net factor payments" + unilateral transfers, (which are the least issue here, though foreign military bases and adventures would play into that somehow, with whatever net). The basic point was that under "Bretton Woods 2", a thoroughly obnoxious term, underlying imbalances in trade were counter-balanced by the difference in "net factor payments", even as the U.S. de-industrialized and wages stagnated and household debts grew. It wasn't "stabilizing", except in the sense that it was stabilizing unsustainable and de-stabilizing dis-equilibria, riding the tiger, so to speak, which has now blown-up in our faces. (For obvious reasons, I tend to focus on the U.S., since that's where I live and know the data-drip, but such CA imbalances were a larger international phenomenon). So I don't think that, aside from, by automatic reflex of accounting identities, they were "inevitable", that those deficits were a "good thing", especially in their composition, but rather that they were part and parcel of the very macro-economic domestic dis-investment from the U.S. economy that you are talking about in noting the dis-investment incentives of stock buy-backs.The tendency to financialize and dis-invest in real productive capital are related to the tendency to financially "arbitrage" investments elsewhere. Which has everything to do with the "strong $", which results from its reserve currency status, since it is the difference between nominal $ and PPP "value" that is being arbitraged, before all else, mostly on north/south lines. And that means that even before wage-differentials, (which get naively focused on), let alone taxes and regulations, it's the capacity to pick up foreign "assets", firms and banks, on the cheap that's at issue. Which then leads on to the domestic version of such arbitrage. As funds flow back into "domestic" stock markets and I-banks. Or, at least, that's my rough sketch idea of how "international macro-economics" actually "works". The better financialized arbitrage "opportunities" abroad generate both returns and pressures for such arbitrage activity "at home".
As for the second half of my comment, I was tweaking your account in two respects, which, since I was just thinking it through, (while busy elsewhere), I might have left too implicit. Point 1) was the "insider trading"-like aspect, as the ostensible intention of aligning top managers with share-holder "interests" by rewarding them with stocks and options rather than salaries "backfired" by aligning managers with financial interests, involved in trading M&A and much else, against the diffuse "mass" of shareholders, (let alone "stake-holders"). In turn, the exclusive focus on short-run share prices became a defensive (or offensive) operation against the threat of take-overs to management, such that firms are competing on financial rather than product markets. Point 2) was that there is a subtle difference between the performance and functioning of equity markets, (though I have no idea how large a factor this might be), when returns from real productive investment are re-cycled back into equity markets via dividends, and thus the circular flow of money out of and into such markets, and the results of buy-backs financed by I-bank debt leveraging the market. In the first case, successful real investment projects result in increased dividends, which then should increase stock-prices, cap. gains, to restore price/yield ratios, whereas in the latter case stock-prices are rising precisely because the balance-sheet of the firm is being degraded. Whether the latter is clearly on balance sheet or not, it amounts to a perverse price-signal and adds to the opacity of the market. The apogee of both these tendencies would be the case of a bank giving a loan to one of its principals in order to buy bank shares and thereby increase the banks equity, which happened in Iceland and perhaps a few cases elsewhere, though I would think it clearly an illegal fraud, but might have occurred in more complicated schemes much more broadly. But all awards of stocks and options, without expense to share-holder equity, partake dimly of such a flavor.
Thanks for the tip, J.W. It's apparently a cookie problem.
W:
The first part of my remark was in response to your response to R.L. cited, not the OP, but any way…
I might have erred in starting rhetorically with the Bushevik tax cuts, since it's a much longer running tendency of the emergent Wall St./MNC neoliberal regime than just that. It just struck me as a particularly "good" example of how the conjoined tendencies of globalization and financialization work.
But the CA deficit consists in the trade deficit + "net factor payments" + unilateral transfers, (which are the least issue here, though foreign military bases and adventures would play into that somehow, with whatever net). The basic point was that under "Bretton Woods 2", a thoroughly obnoxious term, underlying imbalances in trade were counter-balanced by the difference in "net factor payments", even as the U.S. de-industrialized and wages stagnated and household debts grew. It wasn't "stabilizing", except in the sense that it was stabilizing unsustainable and de-stabilizing dis-equilibria, riding the tiger, so to speak, which has now blown-up in our faces. (For obvious reasons, I tend to focus on the U.S., since that's where I live and know the data-drip, but such CA imbalances were a larger international phenomenon). So I don't think that, aside from, by automatic reflex of accounting identities, they were "inevitable", that those deficits were a "good thing", especially in their composition, but rather that they were part and parcel of the very macro-economic domestic dis-investment from the U.S. economy that you are talking about in noting the dis-investment incentives of stock buy-backs.The tendency to financialize and dis-invest in real productive capital are related to the tendency to financially "arbitrage" investments elsewhere. Which has everything to do with the "strong $", which results from its reserve currency status, since it is the difference between nominal $ and PPP "value" that is being arbitraged, before all else, mostly on north/south lines. And that means that even before wage-differentials, (which get naively focused on), let alone taxes and regulations, it's the capacity to pick up foreign "assets", firms and banks, on the cheap that's at issue. Which then leads on to the domestic version of such arbitrage. As funds flow back into "domestic" stock markets and I-banks. Or, at least, that's my rough sketch idea of how "international macro-economics" actually "works". The better financialized arbitrage "opportunities" abroad generate both returns and pressures for such arbitrage activity "at home".
johnhalasz@hotmail.com
Colleagues
I did engineering at college, then economics then articled in accountancy. I had a corporate career and an international consulting career. Please remember that money and banking is merely the lubricant of the economy. The gas for the economy comes investment in activities that create real value and improve productivity to support quality of life.
My perspective on macroeconomics is that an economy is in trouble when the most powerful sectors are banking and government. These two sectors in the US have grown more and more powerful over time … while the underlying real economy lost its global preeminence. This accelerated in the period since 1980! More and more of the real economic product going to the ownership sectors!
Josh – do you really think that this era is best understood as the assertion of shareholder power contra management – by paying CEOs exorbitant amount to disgorge the cash? I find that hard to believe. Instead, it seems to me that this is a time when managerial prerogative actually increased, and they found it easier to set their own pay during an era of a diminished "outrage constraint" (Bebchuk, Fried and Walker).
Is it that surprising that management (even a management that was acting without a strong principal, let alone principles) would pay out more in dividends if part of the money it was making was simply higher returns from asset holdings during a bubble period? Does it necessarily tell us much about balance of forces between management and shareholders?
Well, it would be foolish to be too confident. So I'll say that I think it's a compelling enough story as told by Doug H., Dumenil and Levy, Smithin, and from the other side by Jensen, etc. that it's worth developing and sharing with people.
One of the complications here is that we're not talking just about two fixed sides here. It's not so much that a coherent group of asset-owners coerced a coherent group of managers into behaving differently (altho of course in certain cases that did happen). The big success of the asset-owners was to reduce the extent to which managers were a distinct sociological group capable of acting with some autonomy. In other words, it wasn't so much about one set of interests conflicting with another (tho again, sometimes it has been) as about a redefinition of what the interests of managers are.
That probably sounds a bit vague and woolly. What I mean is, it really does seem that firms are more oriented toward maximizing shareholder value than they were in the postwar decades. I think — certainly many people at the time thought — that firms in the 50s, 60s and 70s often pursued a range of objective other than maximizing the discounted flow of payments to shareholders, just as firms in countries with less stock-market oriented financial systems (like Japan) still do. And again, if you look at what people involved in the hostile takeover/leveraged buyout wave of the 1980s were actually saying, it was essentially that management is too interested in growth, market share, new technology, prestige projects, good relations with their workers, etc., and is prioritizing that stuff over maximizing payments to shareholders. Which is why the threat of takeovers is needed, and why top management needs to be compensated like shareholders rather than employees. This doesn't mean it's true — maybe it was just a sales pitch. But I think it does mean it's an idea worth taking seriously.
Now obviously once the new norms got established individual managers could take advantage of them. And there's the argument made in that excellent Enronitis paper I've linked to here before — that once you have a culture of management that sees it as morally praiseworthy to ruthlessly take advantage of every stakeholder except shareholders, it's inevitable that some will try to take advantage of shareholders as well. But I think it's hard to argue that managerial prerogatives have not declined vis-a-vis shareholders (as opposed to workers or society at large) over the past 30 years. It would be a great question to try to explore more systematically, tho. (As a friend said to me the other day: "So many great questions, so few good answers.")
On your second comment, I don't know. Is it surprising that firms would pay out the gains from bubbles to shareholders? One might turn it around and say that it's surprising that firms pay any dividends at all. Of course, *if* the firm really is managed so that shareholders are the residual claimants, and *if* the wedge between internal and external finance is not too great (i.e. if markets are perceived to allocate capital as well as the firm can internally), then a firm that receives a windfall of some kind (asset appreciation in a bubble, say) should just pay it out to shareholders. But the argument is precisely that those conditions didn't apply before 1980 to the extent that they have since.
And there really does seem to be a difference from the postwar decades. There's a secular upward trend in dividends and an even larger secular upward trend in dividends + buybacks, and much more cyclical fluctuation in payouts. I think it's hard to make sense of this if you don't think the objective function of management has shifted in some way. But I'm open to being convinced otherwise.
Worth pursuing further … for now, my view of the world is that there were (at least) two distinct phases … First was the emergence of a market for corporate control through hostile takeovers in the 1980s, which may have changed managerial incentives to basically ward off such possibilities. However, it didn't lead to greater power of shareholders over management … consolidation and mergers over time ended up actually increasing managerial prerogatives. However, it was of course a very different type of management … one whose incentives were quite aligned with short term capital gains which were also potentially helpful to ward off challenge for control. And one where they could pay themselves an exorbitant amount all in the name of "incentives." So yes, the market for corporate control changed the world – but ironically it changed it by passing more rents to managers, not less. And at least some of this additonal managerial rent came from shareholders. Nowhere was this more clear than the way stock options were expensed or reported in the annual reports during the nineties… Anyway, I would be interested to talk more about this – maybe I'm wrong.
A clarification: I think the emergence of the market for corporate control redistributed rents across different types of shareholders – away from institutional investors such as pension funds and towards more aggressive agents in the capital market.
Interesting post. But one question: you note that payouts of dividends + repurchases exceed after-tax net earnings. But how is this possible without depleting capital stock, or is this relatedly separately to tax issues or something, because I am a bit puzzled at how such a difference can be maintained year after year.
Good question!
In fact, there has been some depletion of the capital stock. If you look at the BEA's fixed asset tables, you'll see that the stock of private nonresidential fixed assets is actually lower in 2010 than in 2008, which is pretty extraordinary. But that's unique to the Great Recession. The longer trend is accounted for by an increase in corporate borrowing. In principle, businesses can pay out more than their total profits indefinitely if their debt levels can rise continuously.
(Also, the one rule I try to have for comments here is that people use some a handle of some kind, it doesn't matter what. It gets confusing when multiple people are commenting as "Anonymous".)
Nice!
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In principle, businesses can pay out more than their total profits indefinitely if their debt levels can rise continuously.
That makes sense then. Capital inflows from abroad account for additional dividends + repurchases, which explains the change of the US from net creditor to net debtor.
There's also something else which is going to need a bit of clarification: i.e. the definition of profits. I can't remember if some capital costs are deducted from post-tax profits in accounting practices.
Assume you're right; corporations today are more focused on returning value to shareholders, relative to their historical peers. Some questions:
1) Why is this bad? Your argument hinges on the thesis that, ceterus perebus, more cash distributions to investors means foregone alternatives for the corporation, like research and development. Is there evidence that this is so? Has the aggregate pace of innovation slowed by any objetive measure?
2) Let's assume that there is, and that it has. Again, why, and so what? Investors and management have a powerful incentive to maximize investment value. It must be the case that the foregone alternatives promised less discounted value to the investor than the immediate cash-out, relative to HIS alternatives.
3) Where does the money go? You propose earnings retained by companies are "good", while earnings returned to individuals are "bad". This doesn't seem to follow. Investors can do one of two things with investment profits: spend them, or save them. If saved, the effect on net investment is nil; I don't see any reason to suspect that the company is more able to invest shareholder dollars than the investor, and if it were, no rational investor would demand his dollars back. If spent, aggregate demand must go up – prompting the company to increase production and the individual to increase investment.
4) You cite an article referencing Apple. This is useful. There has been tremendous innovation in the technology sector over the past 30 years. That sector also retains invested capital at far greater rates than the broader economy, without any significant shareholder revolt. Why is this sector treated differently by shareholders than the aggregate?
If corporations are returning capital to shareholders at greater rates today than previously, and capital is no more constrained today than then, it must be the cae that this is the most efficient market allocation. Your hypothesis in the comment above that management in the past was less focused on maximizing investor value than management today strikes me as particularly odd. Managers compete for investment dollars. My interest in buying AAPL is not seeing what cool things Steve comes up with next, but in earning the greatest return on principal the market affords me. This has ALWAYS been true. If managements attitudes have changed, it is both a "good thing", and the product of a change in market composition – perhaps today the United States simply has to compete for scarce investment dollars in a way it has not had to, historically. I don't think it follows that a) investor value is only maximized by buy-backs and dividends or b) investors believe their value is only maximized this way. You show this yourself, in the Jobs anecdotes.
Here's my own, speculative and humble hypothesis for the trend:
a) International competition for investment dollars means companies must be more focused on creating and retaining investor loyalty.
b) Increased investment flows – radically increased, I would speculate – by the popularization of investing both in the US and abroad has improved the corporate capital position much more rapidly than needed to keep up with demand. Corporations respond to the cash surplus by returning capital to owners – a better proposition for the investor than seeing his principal wasted on useless production.
c) Changes in the bond and loanable funds markets have reduced the risk and stigma of corporate debt. Corporations are able to meet their operating demand more cheaply – given the relatively high cost of capital and low cost of debt – by borrowing than by selling.
d) Changes in the American regulatory climate have made it more difficult for domestic companies to expand production today relative to the post-war era of rapid industrialization.
Glenn,
Thanks for the response, and sorry for the slow reply.
On 1, the clearest outcome that is changed for the worse is investment. Over the 25 years from 1961 and 1985, the total stock of nonresidential fixed assets grew at about 3.6 percent annually. Over the next 25 years, from 1986 to 2010, the growth rate was 2.4 percent. That's a pretty big deceleration. The reorientation toward shareholder value probably also one reason why wages have been falt over the same period. While there are obviously lots of reasons why workers' bargaining position has gotten weaker, from the decline of unions to intensified competition from imports, minimizing labor costs is probably a higher priority for management in the neoliberal era than it was in the postwar period. And again, this is exactly what the shareholder revolution was supposed to accomplish. When people like Jensen argued for an increased shareholder role in corporate governance, it was precisely in order to reduce what they saw as excessive investment and generosity to workers.
Point 2 assumes what I think is (or should be) in question, that the firm exists for no other reason that to maximize its discounted present value for the shareholders.
If saved, the effect on net investment is nil; I don't see any reason to suspect that the company is more able to invest shareholder dollars than the investor, and if it were, no rational investor would demand his dollars back. If spent, aggregate demand must go up – prompting the company to increase production and the individual to increase investment.
Here we get to the heart of the matter. First of all, the key insight of Keynes is that it is *not* the case that the decision of an individual to save necessarily calls forth an equivalent increment in investment. And in particular, saving that takes place within the firm (in the form of retained earnings) is channeled into investment much more reliably than saving by households. It's true that total savings must equal total investment as a matter of accounting, but if households decide to increase the share of their income they save, that macro equality can be — and often is — maintained by a fall in total income rather than a rise in investment.
It's also not the case that if there is a large wedge between the cost of internal and external funds to the firm, investors will not demand "their" money back. Investors may place a high value on liquidity (this will be the subject of another post soon), or have a higher discount rate, or be more risk-averse, or there may be information asymmetries between management and shareholders, all of which could cause "rational" investors to demand payouts even when the firm has high expected value projects available that could be more cheaply financed internally. Finally, you are right that consumption out of payouts will stimulate demand — that's a big reason why we had something like full employment in the late 90s. But an economy oriented around rentier consumption looks quite different from one oriented around productive investment.
On 4, you are absolutely right that the tech sector has been somewhat immune from this trend (tho that may be changing). It's a very good question why, to which I don't have a good answer.
If corporations are returning capital to shareholders at greater rates today than previously, and capital is no more constrained today than then, it must be the cae that this is the most efficient market allocation.
Here, again, we disagree. Information asymmetries are just one of many reasons why this doesn't follow, even in conventional theory. This also assumes that no one but shareholders has a moral claim on corporate income, which I don't think should be taken for granted.
Your hypothesis in the comment above that management in the past was less focused on maximizing investor value than management today strikes me as particularly odd. Managers compete for investment dollars. My interest in buying AAPL is not seeing what cool things Steve comes up with next, but in earning the greatest return on principal the market affords me. This has ALWAYS been true.
Maybe, maybe not. But what has definitely NOT always been true is that Steve Jobs has to worry about you buying AAPL in order to do cool things. In point of fact, Jobs didn't need to worry about you at all, but in the recent period that was unusual. Before 1980 or 1985, it was typical. Share values were not a major constraint on corporate decision making.
On your hypothesis, I think c is definitely true, but the others are not. Something like d could be true, if we broaden "regulatory climate" to include a broader set of factors influencing the profitability of new fixed investment. On a and b, I think you are missing the point that equity is not an important source of investment finance.
Discount I thought switching to AT&T was a good thing. Unfortunately, I am finding out that AT&T is pretty much useless to me in regards to the Nexus One. It does not support the AT&T 3G frequency…
Discount
The reason large technology companies have been exempt from this is that they tend to be relatively young companies that are largely owned by people who founded them. Apple, Google, Microsoft, they all get the same message from Wall Street: "Why are you investing in new businesses? Just milk your existing businesses for all they're worth, give the money to us, and we'll invest in elsewhere." But ultimately those shareholders don't get their way because so much of the company is owned by people with a sentimental attachment to the company, who are at least as interested in seeing their baby grow up and succeed as they are in seeing their billions turn into a few more billions.
And it's a blessing. IPO is the very last time a company gets anything from its shareholders; once Wall Street takes over and reaps the dividends there is no more reinvestment in the company. Steve Jobs' stock portfolio was not very well balanced. And as long as he was alive, Apple did not pay dividends.
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JW, I'm trying to understand why your dividend payout ratio differs so much from the trends we see in the S&P500. What data from Flow of Funds did you use in the graph?
Thanks