payouts as reallocation

Profits, Payouts and Equity Prices, Part 1

TLDR: The value of corporate equity relative to GDP is at a historical high. But this does not necessarily mean there’s a bubble: profits and shareholder payouts are also very high relative to historical values.

I first started thinking about economics thirty years ago, during the (first) tech boom.

This was the era of “irrational exuberance,” the phrase coined by the recently deceased Alan Greenspan and made famous by Robert Shiller. I wrote a review of Shiller’s book of that title for In These Times — one of my first published articles. My first paper in graduate school was a replication of a paper by Brad DeLong and Larry Summers¹, which argued that seemingly excessive stock valuations could be explained by rational investors extrapolating recent earnings growth into the future.

All of which is seeming at least a little bit relevant today.

Between the start of 1995 and the end of 1999, the price-earnings ratio for the S&P 500, as measured by Shiller, more than doubled, from 20 to nearly 44. Then over the next three years, it fell back nearly as far. Today, price-earnings ratios by the same metric are just shy of 40, not far from the peak of the first tech boom. Everything old is new again, it seems. (Except that, as Paul Krugman notes, people generally liked the products of the first internet companies.) So the obvious question is whether this is also a bubble — whether the second half of the late-1990s story will get a rerun as well.

There are many people out there with highly specialized expertise whose whole job is to think about stock valuations. I am not one of those people! If you are looking for investment advice, you have come to the wrong blog.

But I do think I have something to add.

Most of what makes financial-analyst jobs hard has to do with specific companies and specific markets. Things get easier when we are looking at the stock market as a whole. (And that is where my own background in heterodox macro is more likely to help.) When we are talking about corporate equity in the aggregate, rather than individual securities, some arithmetic comes into play that helpfully limits the space of possibilities.

One way to think of a share is that it gives a claim on future payments by the corporation that issued it. This is not all that a share is — as Arjun and I stress in Against Money, it’s important to keep sight of financial assets’ existence as concrete objects with their own specific properties, and not reduce them to simply a future cashflow. But certainly the cashflow it gives claim to is one very important property of a share.

Again, the value of share is not reducible to present value of expected (in either the statistical and/or psychological sense) future payments. But those should act as an anchor. Unless we have good reason to think there is a change on value market participants put on future payments, we should expect share prices to vary roughly in proportion to them. And even if we think valuation of shares can vary indefinitely with respect to payments they give claim to, it’s worth knowing how much of current share prices would have to be explained in these terms, and how much can be explained by variation in the payments.

In the rest of this post, I am going to look at the US nonfinancial corporate sector. This means excluding the 20-25% of corporate equity issued by financial businesses, and including closely-held corporations as well as those listed on public exchanges. This is mainly because that’s the universe for which it’s easiest to get consistent data. But I also think it’s a reasonable thing to be interested in substantively.

If we look at nonfinancial corporate equity over the 80 years since World War II, here is what we see:

The figure shows the total value of nonfinancial corporate equity,as a share of potential GDP. (I am skeptical of potential as a measure of actual economic potential, but here it is just functioning as a trend, to smooth out short-term changes in the denominator.) This, I would argue, is the most straightforward measure of the value of the stock market in broad social terms — how much claim wealth in this form gives on social labor and its products. This is also, of course, the metric used by Piketty.

As the figure shows, stock market value in that sense has had three long upswings. The first peaked in the late 1960s at 0.9, the second in 2000 at 1.6, and the third is ongoing, with the ratio currently at 2.3. (The data in this post is drawn from the Fed’s Financial Accounts, and goes through the first quarter of 2026.) Over the long run, there is a clear upward trend, especially over the past 15 years. (The dotted line shows the post-WWII average.) By this metric, the current stock market boom has now run well ahead of the late 1990s one.

How should we think about this?

Logically, the value of corporate equity relative to GDP must reflect a combination of four factors: value added in the corporate sector as a share of GDP; corporate profits as a share of their value added; payouts to shareholders as a percentage of profits; and the value placed by markets on each dollar of payouts.

In other words, if corporate stock is worth more relative to GDP, that can be either because more of GDP is now happening in the corporate sector; or because more of the income from that activity is going to profits; or because more of those profits are being paid out to shareholders (rather than retained in the firm); or because financial markets place a greater value on each dollar of payment. Or of course some combination of those.

We can write this as an accounting identity:

equity/GDP = value added/GDP * profits/value added * payouts/profits * equity/payouts

As with any accounting identity applied historically, it is useful insofar as it corresponds to (1) categories in the relevant data, and (2) distinct causal factors we believe to be at work.

For the first term, we are, again, using all nonfinancial corporate equity, which includes closely held as well as publicly-traded corporations, and the BEA’s estimate of potential GDP. (Both are in current dollars.) Value added is defined, as usual, as sales less the cost of non-labor inputs. Profits are after tax (and of course also after depreciation); conceptually, these are the funds potentially available for distribution to shareholders.²

Payouts I am defining as dividends less net new equity issues. That share repurchases are conceptually equivalent to dividends is not, I think, too controversial at this point (though it creates a lot of headaches). We are also adding shares retired through cash acquisitions, and subtracting shares issued whether in IPOs or otherwise. This might seem odd at the level of an individual firm, but at the aggregate level these other flows seem clearly equivalent to buybacks and dividends. If firm A buys up all the shares in firm B for cash, that is a payment from the corporate sector to shareholders, just as if firm A were buying back its own shares. Similarly, new shares issued are a reduction in the aggregate payments from the corporate sector to shareholders just as a reduction in dividend payments would be.

It might sound strange to define IPOs (which generally are quite exciting for stock market participants) as equivalent to dividend reductions (which generally are not.) But this is where the aggregate perspective matters. Shareholders as a whole already own all the equity of the corporate sector as a whole. An IPO is a payment from shareholders to the corporate sector, exactly like buyback is a payment from the corporate sector to shareholders, without in either case any change in aggregate ownership rights. Or looking at it from another point of view, new corporations are in general competing with existing firms; the profits flowing out to shareholders of the new firm are to a first approximation deductions from the profits flowing to claimants on existing firms. Nice for the shareholders in the new firm, if it succeeds; but no use to shareholders as a class.

Finally, the valuation term asks, in effect, what is the market price of a dollar of income from the corporate sector. It’s analogous to the price-earnings or price-dividend ratios one sees at the level of individual corporations or indexes, though not identical given the nonstandard (but, I would argue, appropriate) way I have defined payouts. Here it also functions as the residual term, reflecting any change in the value of equity not explained by the other factors.

The figures below show the values of each of these terms over the past 80 years. What do we see?

We will start with the first term, corporate value added as a share of GDP. This shows how much of economic activity takes place in the corporate sector, and is potentially available for shareholders.

As it turns out, the corporate value added term does not do anything interesting. Yes, it is modestly lower (around 50 percent) after 2000 than its average in the earlier decades (53 percent), suggesting that all else equal, we might expect the value of corporate equity to be slightly lower relative to GDP in the 21st than in the 20th century. But this change is very small compared with the movements in the other terms. This factor might be important if we were comparing the US to other countries, but it is not part of the story here.

Next, profits:

Profits as a share of value added shows much more variation, falling by half in the 1980s, then rising in this century, in two big jumps — one after 2000 and the second over the past five or so years. While the corporate share of GDP doesn’t vary by even 10 percent over the whole period, profits as a share of value added are fully three times greater today than they were for much of the 1980s.

The third term is payouts.

Payouts (as I’ve defined them) also show large variation, rising from a bit under 40 percent of profits in the early decades to over 80 percent in more recent ones. The timing here is a bit different — though there is plenty of short-term variation, the long-run shift happens in a single big jump in the early 1980s. (This was the topic of an essay in my dissertation, which I never managed to publish as an academic article but did turn into a report for the Roosevelt Institute.) This term gets relatively little attention in discussion of stock prices, but it seems to me that it is as fundamental as profits to any discussion of long-term trends in the value of corporate equity.

Finally, the valuation term shows a lot of short- and medium-term variation but, perhaps surprisingly, no long run trend. Today’s ratio of around 40 is close to what we see in the 1950s and 1960s.

Again, what we are measuring with this last term is the ratio of equity value to shareholder payouts, including net share repurchases. The big spikes in the early 1970s and in 2000 are because those years saw exceptionally high new equity issues, which means very low payouts by my metric, and therefore very high ratios of equity value to payouts.

It is more common to talk about equity in relation to earnings, on the implicit assumption that profits are of equal value to shareholders whether they are paid out or not. I’ve shown this latter ratio below. But personally, I do not think that that is a good assumption. Shareholders evidently care a great deal about payouts — why else would companies pay dividends and make share repurchases? I think it is important to distinguish between corporations and the shareholders who exercise claims on them — the former are not simply the personal property of the latter. From this point of view, it is more natural to talk about valuation in terms of the price shareholders place on the income they actually get from corporations, as opposed to the underlying profits.

All of these series (except the last one) are combined in the next figure, which is really the whole point of this post. If you take one thing from one I’ve written here, this picture is it.

Equity value relative to GDP and its components, 1947-2026:

For this figure, I’ve converted the values to logs. This has the big advantage of converting the multiplicative relationship to an additive one, so that we can visually see the contribution made by each of them. But it can make interpreting the figure a bit tricky. Here, zero is the average value over the full period; positive one is a value about 2.7 times greater than the average, while negative one is a value about one-third of the average. The black line similarly describes the deviation of the equity-GDP ratio from its full-period average; the heights of the bars correspond to the contribution each term makes to that deviation. The data is quarterly; for all the terms except equity, I use rolling one-year averages.

As we can see, the log of the equity-GDP ratio is currently about 1.1 above its long-run average, corresponding to a value nearly three times greater. (2.2 today, versus a long run average of 0.85.) Just over half of this (0.53) is explained by higher profits relative to value added, 0.19 is explained by higher payouts relative to profits, and 0.36 is explained by the valuation term.

So already we can see that a simple explanation of today’s high equity values is going to be incomplete. Relative to the long-run average, we have three distinct factors each of which explains a significant share of today’s higher values.

Another thing that jumps out from the figure is that the previous historical peaks in equity values reflect quite different mixes of these components.

In the 1960s, profits as a share of value added were, for a while, well above average, though not as high as today; but the fraction of those profits flowing out to shareholders was much lower. Thus the much lower ratio of equity to GDP, despite comparable valuation ratios.

In the late 1990s, profits as a share of value added were much lower — less than 5 percent at the height of the tech bubble, compared with 10 percent in the 1960s and 15 percent today. But the fraction of profits paid out to shareholders was historically high, averaging over 100 percent for the 1998-2000 period. It’s worth noting in this context, also, that the collapse of equity value in the 1970s reflected a fall in shareholder payouts much more than in profitability; this is perhaps important context for the shareholder revolt that followed.

The big takeaway from this decomposition is that we should be cautious about assuming the stock market is overvalued — that we’re in a bubble, that this is another bout of irrational exuberance — simply because equity prices are high relative to the historical norm. Shareholders have it better than the historical norm, too. Corporations are more profitable. And more of those profits are flowing out to them. A bit of exuberance might be rational, under the circumstances.

On the other hand: If we focus on just the past 20 years, as in the figure below, the picture looks a bit different.

Yes, both profits and payouts are high relative to their long-run averages; but those shifts mostly came earlier, while the big rise in equity prices is more recent. Apart from the relatively brief collapse in profits during the Great Recession, almost all the variation in equity prices over the past two decades comes from the valuation term, rather than changes in the underlying payments to shareholders.

This is even more true over the past two years — equity values have increased sharply while profits have been stable and aggregate payments to shareholders have fallen, as dividend growth has stalled and net equity issue has turned positive. As a share of GDP, the net payments flowing from corporations to shareholders today are very close to where they were a decade ago; but corporate equity is worth 60 percent more. It’s hard to avoid the conclusion that either equity was undervalued in the mid-2010s, or it is overvalued now.

So which side do we focus on? Over the long run, most — tho not all — of the increase in the value of wealth in the form of corporate equity, is explained by what we might call fundamentals — the flow of payments to owners of that wealth. Over the short to medium run, on the other hand, almost all of the increase in the value of equity comes from valuation, and whatever financial-market dynamics drive that. Or as the old saying goes, in the short run the market is a voting machine, but in the long run it’s a weighing machine.

I want to say a bit more about the profits and payouts parts of the picture.

That high stock prices reflect to some extent a high level of corporate profits seems to be reasonably well understood, at least based on recent coverage in the Financial Times. This of course does not mean that high stock prices are justified, or sustainable; it just shifts the question to how justified or sustainable the high profits are.

This goes double to the extent that high valuations are based on an expectation of further increases in profits, as this recent FT piece suggests:

Wall Street’s expectations for company profit growth are rising at the fastest pace since the post-pandemic rebound, fuelling concern that an “earnings bubble” could be forming in the estimates that have underpinned the US stock market’s rally.

Analysts are now forecasting a 25 per cent increase in S&P 500 company earnings for the coming year, according to Bloomberg data, boosted by a resilient US economy and the AI boom.

However, just ahead of the second-quarter earnings season, some investors are growing concerned about the speed at which analysts’ estimates are rising…

This Alphaville piece goes further, saying that “supernormal profits are unsustainable, because they always are.” I don’t know about that. I don’t know if there’s any reason to think the profit share is stationary, to use the statistics jargon — apart from a dip in 2008-2009, profits as a share of value added have been greater than their long-run average in every year of this century, and seem to be getting farther from it. Capital really has won some lasting victories in the class war.

That is one natural way to look at profits — as a distributional variable. But there’s another way of looking at them, from the demand side.

We know, as readers of Keynes, that an increase in investment automatically creates an equal quantity of additional saving. If, furthermore, there’s little or no incremental saving out of wage income (a reasonable assumption, in my opinion) and if the fiscal balance and trade balance don’t change significantly (perhaps less reasonable, but we’ll go with it) then this additional saving must take the form of an increase in profits. This relationship is often known as the Kalecki-Levy profits identity, and is one bit of heterodox economics that has established a foothold in finance and the business press. The same identity says that an increase in the fiscal deficit or trade surplus should similarly lead to an equal increase in aggregate profits.

Exploring the math of this and the extent to which it is a reasonable first approximation of real-world dynamics would be an interesting exercise for another post. But it raises another point which I think is very relevant for thinking about the current situation: Even if the AI companies themselves are not particularly (or at all) profitable, AI-related investment spending is probably an important factor in raising aggregate profits. Just like the California gold rush generated plenty of profits for somebody, even if the vast majority of prospectors themselves went broke.

Or as this recent FT piece puts it:

The AI boom is lifting the fortunes of hundreds of formerly drab industrial, utility and mining companies as investors turn to the “picks and shovels” needed to build and power vast data centres. …

The companies benefiting include Caterpillar, best known for construction equipment but now supplying generators for data centres, 150-year-old German engineering company Hochtief, which will enter the Dax later this month, and Nucor, a steel supplier that has credited “white hot” AI demand for a “tsunami of earnings power”. …

The vast amounts of electricity needed for AI training are also fuelling demand for specialised power management, high-voltage electronics and cooling technologies. This has led to big interest in traditional suppliers of electrical equipment…

You could think of it like this: As long as there is strong investment demand and easy financing for it, the profits will be there …. but not necessarily for the companies carrying out the investment and getting the financing.

And this, perhaps, is the point where the macro perspective needs to give way to the micro one. Because it may be that, yes, in the aggregate, an ease in financing brings forth additional investment, which generates enough profits to justify the initial financing. But debt must be paid back not in the aggregate, but by the specific companies that incurred it. If the investment is one place and the profits are somewhere else, then at some point somebody’s survival constraint is going to be violated.

And I think I will end this post here.

I very much want to discuss the payouts piece of the equation, which in my mind is as important as profits, and much less discussed. But this post is already too long, and has taken much too long to write. So the payouts piece should be along, well, if not this month, then next month, or soon.

“The Money Has to Go Somewhere” – 1

A common response to concerns about high payouts and the short-term orientation of financial markets is that money paid out to shareholders will just be reinvested elsewhere.

Some defenders of the current American financial system claim this as one of its major virtues — investment decisions are made by participants in financial markets, rather than managers at existing firms. In the words of Michael Jensen, an important early theorist of the shareholder revolution,

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. [Private equity fund] KKR’s New York offices … are direct substitutes for corporate headquarters in Akron or Peoria.

But while private equity funds do indeed replace exiting management at corporations they buy shares in, this form of active investment is very much the minority. The vast majority of “investment” by private shareholders does not directly contribute any funding to the companies being invested in. Rather, it involves the purchase of existing assets from other owners of financial assets.

Suppose a wealthy investor receives $1 million from increased dividends on shares they own. Now ask: what do they do? Their liquidity has increased. So has their net wealth, since the higher dividends are unlikely to reduce the market value of the shares and may well increase them. The natural use of this additional liquidity and wealth is to purchase more shares. (If the shares are owned indirectly, through a mutual fund or similar entity, this reinvestment happens automatically). But this purchases of additional shares does not provide any funding for the companies “invested” in, it simply bids up the prices of existing shares and increases the liquidity of the sellers. Those sellers in turn may purchase more shares or other financial assets, bidding up their prices and passing the liquidity to their sellers; and so on.

Of course, this process does not continue indefinitely; at each stage people may respond to their increased wealth by increasing their cash holdings, or by increasing their consumption; and each transaction involves some payments to the financial industry. Eventually, the full payout will leak out through these three channels, and share prices will stop rising. In the end, the full $1 million will be absorbed by the higher consumption and cash holdings induced by the higher share prices, and by the financial-sector incomes generated by the transactions.

Now, not every share purchase involves an existing share. But the vast majority do. In 2014, there were $90 billion of new shares issued through IPOs on American markets — an exceptionally high number. By comparison, daily transactions on the main US stock markets average around $300 billion. Given around 260 trading days in a year, this implies that only one trade in a thousand on an American stock exchange involves the purchase of a newly issued share. And that is not counting the many “stock market” transactions other than outright share purchases (closed-end mutual funds, derivative contracts, etc.) all of which allow income from shareholder payouts to be reinvested and none of which provide any new funding for businesses.

External financing for businesses is much more likely to take the form of debt than new shares. But here, again, we can’t assume that there is any direct link between shareholder payouts and funding for other firms. Corporate bonds are issue by the same established corporations that are making the payouts. Meanwhile, smaller and younger firms, both listed and unlisted, are dependent on bank loans. And the fundamental fact about modern banks is that their lending is in no way dependent on prior saving. There is no way for higher payouts to increase the volume of bank lending. Banks’ funding costs are closely tied to the short-term interest rate set by the Federal Reserve, while their willingness to lend depends on the expected riskiness of the loan; there is no way for increased payouts to increase the availability of bank loans.

New bonds, on the other hand, do need to be purchase by wealthowners, and it is possible that the market liquidity created by high payouts has helped hold down longer interest rates. But many other factors — especially the beliefs of market participants about the future path of interest rates — also affect these rates, so is hard to see any direct link between payouts by some corporations and increased bond financing for others. Nor do new bonds necessarily finance investment. Indeed, since the mid-1980s corporate borrowing has been more tightly correlated with shareholder payouts than with investment. So if payouts do spill over into the bond market, to a large extent they are simply financing themselves.

Defenders of the financial status quo suggest that it’s wrong to accuse the markets as a whole of short-termism, since for every established company being pressured to increase payouts, there is a startup getting funded despite even when any profits are years away. I certainly wouldn’t deny that financial markets do often fund startups and other small- financially-constrained firms; and these firms do sometimes undertake socially useful investment that established corporations for whatever reason do not. And in principle, shareholder payouts can support this kind of funding both directly, as shareowners put money into venture capital funds, IPOs, etc.; and indirectly, as higher share prices make it easier to raise funds through new offerings. But the optimistic view of shareholder payouts not sustainable once we look at the magnitudes involved. It is mathematically impossible for the additional funds directed to new firms, to offset what they drain from established ones.

Again, IPOs in 2014 raised a record $90 billion for newly listed firms. (Over the past ten years, the average annual funds raised by IPOs was $45 billion.) Secondary offerings by listed firms totaled $180 billion, but some large fraction of these involved stock-option exercise by executives rather than new funding for the corporation. Prior to an IPO, the most important non-bank source of external funding for new companies is venture capital funds. In 2014, VC funds invested approximately $50 billion, but only $30 billion of this represented new commitments by investors; the remaining $20 billion came from the funds’ own retained profits. (And there is some double-counting between VC commitments and IPOs, since one of the main functions of IPOs today is to cash out earlier investors.) Net commitments to private equity funds might come to another $200 billion, but very little of this represents funding for the businesses they invest in — private equity specializes, rather, in buying control of corporations from existing shareholders. All told, flows of money from investors to businesses through these channels was probably less than $100 billion.

Meanwhile, total shareholder payouts in 2014 were over $1.2 trillion. So at best less than one dollar in ten flowing out of publicly-traded corporations went to fund some startup. And this assumes that shareholder payouts are the only source of funds for IPOs and venture capital; but of course people also invest in these out of labor income (salaries are a significant fraction of even the highest incomes in the US) and other sources. So the real fraction of payouts flowing to startups must be much less. There simply isn’t enough room in the limited financial pipelines flowing into new businesses, to accommodate the immense gusher of cash coming from established ones. Apple alone paid out $56 billion to shareholders last year, or nearly twice total commitments to VC funds. Intel, Oracle, IBM, Cisco and AT&T together paid out another $70 billion. [1] It’s hard to understand why, if finance is able to identify such wonderful investment opportunities for its cash, the management at these successful technology companies is unable to. You would have to have a profound faith in the unicorn hunters at Andreesen Horowitz to believe that the $1 billion they invested last year will produce more social value than $10 or $20 or $50 billion invested by established companies — or an equally profound pessimism about the abilities of professional managers. If this is what people like James Surowiecki really believe, they should not be writing about the dynamism of American financial markets, but about whatever pathology they believe has crippled the ability of mangers at existing corporations to identify viable investment projects.

[1] These numbers are taken from the Compustat database of filings by publicly traded corporations.

On Other Blogs, Other Wonders

Links for Friday, September 11:

From my Roosevelt Institute colleagues Mike Konczal and Nell Abernathy, here’s a primer on “financialization“. This term is used widely but not always precisely; most definitions are some tautological variant of “more finance.” Mike and Nell wisely don’t try to provide a single analytical definition, but treat it as shorthand for a number of linked but distinct developments. Especially useful if, like me, you’re always looking for good material on finance and macroeconomics to use with undergraduates.

Also from Mike Konczal: NY Fed Study Should Redefine How We Think About Student Loans and College Costs. There are two interesting points here, from my point of view. First, the fact that loans have a much stronger effect on college costs than Pell grants do, is yet another piece of evidence for the importance of liquidity; in a world without credit constraints, only the subsidy associated with federal student loan programs would affect anyone’s behavior. Second, it develops an argument I’ve been making for years — an important advantage of direct provision of public goods over vouchers and subsidies is that price movement will amplify effect of the former and reduce the effect of the latter.I should add that at CUNY, where I teach, the great majority of the students take on no debt at all, since Pell grants and New York’s Tuition Assistance Program both cover the full cost of tuition and fees.

Over at Jacobin, my John Jay colleague Ian Seda-Irizarry has a useful overview of the Puerto Rican debt crisis.

Related to the disgorge the cash and capital-reallocation topics we’ve been discussing here, Evan Soltas has an interesting post on What Ails the American Startup? He looks at census data that includes all firms, not just the publicly-traded corporations I’ve focused on, and finds the same long-term decline in the share of the economy accounted for by newer firms.

My friend Will Boisvert, whose two posts on nuclear power remain the most widely-read things to ever appear on this blog, is now writing for the Breakthrough Institute. I’m not entirely down with the “ecomodernism” project, but Will is a very smart and careful writer and his stuff there is very worth reading.

Here is my brother on CNBC, talking about the Kim Davis case.

Reallocation Continued: Profits, Payouts, Investment and Borrowing

In a previous post, I pointed out that if capital means real investment, then the place where capital is going these days is fossil fuels, not the industries we usually think of as high tech. I want to build on that now by looking at some other financial flows across these same sectors.

As I discussed in the previous post, any analysis of investment and profits has to deal with the problem of R&D, and IP-related spending in general. If we want to be consistent with the national accounts and, arguably, economic theory, we should add R&D to investment, and therefore also to cashflow from operations. (It’s obvious why you have to do this, right?) But if we want to be consistent with the accounting principles followed by individual businesses, we must treat R&D as a current expense. For many purposes, it doesn’t end up making a big difference, but sometimes it does.

Below, I show the four major sources and uses of funds for three subsets of corporations. The flows are: cashflow from operations — that is, profits plus depreciation, plus R&D if that is counted in investment; profits; investment, possibly including R&D; and net borrowing. The universes are publicly traded corporations: first all of them; second the high tech sector, defined as in the previous post, and third fossil fuels, also as defined previously. Here I am using the broad measure of investment, including R&D, and the corresponding measure of cashflow from operations. At the end of the post, I show the same figures using the narrow measure of investment, and with profits as well as cashflow.

all_broad

For the corporate sector as a whole, we have the familiar story. Over the past twenty-five years annual shareholder payouts (dividends plus share repurchases) have approximately doubled, rising from around 3 percent of sales in the 1950s, 60s and 70s to around 6 percent today. Payouts have also become more variable, with periods of high and low payouts corresponding with high and low borrowing. (This correlation between payouts and borrowing is also clearly visible across firms since the 1990s, but not previously, as discussed here.) There’s also a strong upward trend in cashflow from operations, especially in the last two expansions, rising from about 10 percent of sales in the 1970s to 15 percent today. Investment spending, however, shows no trend; since 1960, it’s stayed around 10 percent of sales. The result is an unprecedented gap between corporate earnings and and investment.

Here’s one way of looking at this. Recall that, if these were the only cashflows into and out of the corporate sector, then cash from operations plus net borrowing (the two sources) would have to equal investment plus payouts (the two uses). In the real world, of course, there are other important flows, including mergers and acquisitions, net acquisition of financial assets, and foreign investment flows. But there’s still a sense in which the upper gap in the figure is the mirror image or complement of the lower gap. The excess of cash from operations over investment shows that corporate sector’s real activities are a net source of cash, while the excess of payouts over borrowing suggests that its financial activities are a net use of cash.

Focusing on the relationship between cashflow and investment suggests a story with three periods rather than two. Between roughly 1950 and 1970, the corporate sector generated significantly more cash than it required for expansion, leaving a surplus to be paid out through the financial system in one form or another. (While payouts were low compared with today, borrowing was also quite low, leaving a substantial net flow to owners of financial assets.) Between 1970 and 1985 or so, the combination of higher investment and weaker cashflow meant that, in the aggregate all the funds generated within the corporate sector were being used there, with no net surplus available for financial claimants. This is the situation that provoked the “revolt of the rentiers.” Finally, from the 1990s and especially after 2000, we see the successful outcome of the revolt.

This is obviously a simplified and speculative story. It’s important to look at what’s going on across firms and not just at aggregates. It’s also important to look at various flows I’ve ignored here; cashflow ideally should be gross, rather than net, of interest and taxes, and those two flows along with net foreign investment, net acquisition of financial assets, and cash M&A spending, should be explicitly included. But this is a start.

Now, let’s see how things look in the tech sector. Compared with publicly-traded corporations as a whole, these are high-profit and high-invewtment industries. (At least when R&D is included in investment — without it, things look different.) It’s not surprising that high levels of these two flows would go together — firms with higher fixed costs will only be viable if they generate larger cashflows to cover them.

tech_broad

But what stands out in this picture is how the trends in the corporate sector as a whole are even more visible in the tech industries. The gap between cashflow and investment is always positive here, and it grows dramatically larger after 1990. In 2014, cashflow from operations averaged 30 percent of sales in these industries, and reported profits averaged 12 percent of sales — more than double the figures for publicly traded corporations as a whole. So to an even greater extent than corporations in general, the tech industries have increasingly been net sources of funds to the financial system, not net users of funds from it. Payouts in the tech industries have also increased even faster than for publicly traded corporations in general. Before 1985, shareholder payouts in the tech industries averaged 3.5 percent of sales, very close to the average for all corporations. But over the past decade, tech payouts have averaged full 10 percent of annual sales, compared with just a bit over 5 percent for publicly-traded corporations as a whole.

In 2014, there were 15 corporations listed on US stock markets with total shareholder payouts of $10 billion or more, as shown in the table below. Ten of the 15 were tech companies, by the definition used here. Computer hardware and software are often held out as industries in which US capitalism, with its garish inequality and fierce protections of property rights, is especially successful at fostering innovation. So it’s striking that the leading firms in these industries are not recipients of funds from financial markets, but instead pay the biggest tributes to the lords of finance.

	Dividends	Repurchases	Total Payouts
APPLE INC	11,215	45,000	56,215
EXXON MOBIL CORP	11,568	13,183	24,751
IBM	4,265	13,679	17,944
INTEL CORP	4,409	10,792	15,201
ROYAL DUTCH SHELL PLC	11,843	3,328	15,171
JOHNSON & JOHNSON	7,768	7,124	14,892
NOVARTIS AG	6,810	6,915	13,725
CISCO SYSTEMS INC	3,758	9,843	13,601
MERCK & CO	5,156	7,703	12,859
CHEVRON CORP	7,928	4,412	12,340
PFIZER INC	6,691	5,000	11,691
AT&T INC	9,629	1,617	11,246
BP PLC	5,852	4,589	10,441
ORACLE CORP	2,255	8,087	10,342
GENERAL ELECTRIC CO	8,949	1,218	10,167

2014. Values in millions of dollars. Tech firms in bold.

It’s hard to argue that Apple and Merck represent mature industries without significant growth prospects. And note that, apart from GE (which is not listed in the the high-tech sector as defined here, but perhaps should be), all the other members of the $10 billion club are in the fast-growing oil industry. It’s hard to shake the feeling that what distinguishes high-payout corporations is not the absence of investment opportunities, but rather the presence of large monopoly rents.

Finally, let’s quickly look at the fossil-fuel industries. Up through the 1980s, the picture here is not too different from publicly-traded corporations in general, though with more variability — the collapse in fossil-fuel earnings and dividends in the 1970s is especially striking. But it’s interesting that, despite very high payouts in several big oil companies, there has been no increase in payouts for the sector in general. And in the most recent oil and gas boom, new investment has been running ahead of internal cashflow, making the sector a net recipient of funds from financial markets. (This trend seems to have intensified recently, as falling profits in the sector have not (yet) been accompanied with falling investment.) So the capital-reallocation story has some prima facie plausibility as applied to the oil and gas boom.

In the next, and final, post in this series, I’ll try to explain why I don’t think it makes sense to think of shareholder payouts as a form of capital reallocation. My argument has two parts. First, I think these claims often rest on an implicit loanable-funds framework that is logically flawed. There is not a fixed stock of savings available for investment; rather, changes in investment result in changes in income that necessarily produce the required (dis)saving. So if payouts in one company boost investment in another, it cannot be by releasing real resources, but only by relieving liquidity constraints. And that’s the second part of my argument: While it is possible for higher payouts to result in greater liquidity, it is hard to see any plausible liquidity channel by which more than a small fraction of today’s payouts could be translated into higher investment elsewhere.

Finally, here are the same graphs as above but with investment counted as it is businesses’ own financial statements, with R&D spending counted as current costs. The most notable difference is the strong downward trend in tech-sector investment when R&D is excluded.

all_narrow tech_narrow oil_narrow

Is Capital Being Reallocated to High-Tech Industries?

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.

Do Shareholder Payouts Fund Investment at New Firms?

Are shareholder payouts a tool for reallocating capital from large, established corporations to the newer, smaller firms with better prospects for growth? If so, we should see this reflected in the investment figures — the shareholder revolution of the 1980s, and the more recent growth of activist investors, should be associated with a shift of investment away from big incumbent firms. Do we see this?

As a simple test, we can look at the share of corporate investment accounted for by smaller and younger firms. And the answer this exercise suggests is, No. Within the corporate sector, there is also no sign of capital being allocated to new sectors and smaller firms. The following figures show the share of total corporate investment accounted for by young firms, defined as those listed for less than five years; and by small firms, defined as those with sales below the median sales for listed corporations in that year. [1]

The share of investment accounted for newer firms fluctuates between 5 and 20 percent of the total, peaking periodically when large numbers of new firms enter the markets. [2] The most recent such peak came in tech boom period of the late 1990s, as one might expect. But the young-firm investment share shows no upward trend, and since the recession has been stuck at its lowest level of the postwar period. As for the the share of investment accounted for small firms, it has steadily declined since the 1950s — apart from, again, a temporary spike during the tech-boom period. Like the investment share of newer firms, the investment share of small firms is now at its lowest level ever.

We come to a similar conclusion if we look at the share of investment accounted for by noncorporate businesses. Partnerships, sole proprietorships and other noncorporate businesses accounted for close to 20 percent of US fixed investment in the 1960s and 1970s, but have accounted for a steady 12 percent of fixed investment over the past 25 years. So the funds flowing out of large corporations sector are not financing increased investment in smaller, younger corporations, or in the noncorporate sector either.

This is not really surprising. Smaller and younger businesses are mainly dependent on bank loans, and shareholder payouts don’t increase bank lending capacity in any direct way. More broadly, it’s hard to see evidence that potential funders of new businesses are liquidity-constrained. Higher payouts presumably do contribute to higher stock prices, and perhaps marginally to lower bond yields, but any connection with financing for new businesses seems tenuous at best.

In any case, whatever the shareholder revolution has accomplished, there does no seem to have been any reallocation of capital to smaller, growing firms. Capital accumulation in the United States is more concentrated in large established corporations than ever.

[1] Data is from Compustat, a database that assembles all the income, cashflow and balance sheet statements published since 1950 by corporations listed on US markets. I’ve excluded the financial sector, defined as 2-digit NAICS 52 and 53 and SIC 60-69. Investment is capital expenditure plus R&D.

[2] I suspect the late-80s peak is an artifact of the many changes of ownership in that period, which are hard to distinguish from new listings.

Do Shareholder Payouts “Allocate Capital”?

With my colleagues at the Roosevelt Institute, I’m working on a long-delayed followup to the Disgorge the Cash paper.

One of the issues we are addressing is this: Aren’t higher shareholder payouts just a way of channeling funds from mature, slow-growing firms to fast-growing sectors that need capital? This has always been one of the main arguments in support of the shareholder revolution. Michael Jensen:

With all its vast increases in data, talent, and technology, 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 and Irwin Jacobs’ Minneapolis base are direct substitutes for corporate headquarters in Akron and Peoria.

Can the data shed light on the claim that high shareholder payouts are just a way that capital markets reallocate scarce funds from stagnant established firms to up-and-coming innovators?

One line of evidence against this claim is presented in my original Disgorge paper, though not explained as clearly as it could have been. As the table below — reproduced from the paper — shows, the correlations of investment with profits and borrowing have weakened not just at the level of the individual firm, but for the corporate sector as a whole. If markets were mainly reallocating capital from the industries of yesterday to the industries of tomorrow, we would expect an inflow of funds into the corporate sector to be associated with a rise in investment somewhere, even if not in the firms that initially received them. But this is not the case — or at least, it is less the case than it used to be. The weakening of the aggregate relationship between cashflow from operations and borrowing, on the one hand, and investment, on the other, suggests that higher payouts from one business are not translated into more investment funding for another.

Now I want to present two more lines of evidence that point in the same direction.

First, we can compare sources and uses of funds for corporations in general with the same sources and uses for corporations in high-technology industries. Second, we can look at smaller and younger firms specifically, and ask if they account for a higher share of investment than in the old days of managerialism, when investment was more internally financed. In the next two posts that’s what I’ll do.