Launching Our Financialization Project with “Disgorge the Cash”

February 25, 2015

So excited to be launching our new Financialization Project. Part of the goal of the project is to define financialization, and we’ve focused on the changes to savings, power, wealth, and society that have occurred over the past 35 years. We’ll have more there soon.

We’re also releasing our first paper, “Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment,” by Roosevelt fellow J.W. Mason. There’s a great writeup of the paper by Lydia DePillis – “Why companies are rewarding shareholders instead of investing in the real economy” – at the Washington Post.

There’s a ton in there, from the key intellectual, ideological, legal, and institutional changes that brought about the shareholder revolution, to reasons to doubt a credit crunch has played any kind of role in the Great Recession. But the core of it is told in these two graphs, dug out from detailed Compustat data:

The first figure shows that a firm borrowing $1 would correlate with an additional 40 cents of investment before the 1980s. Since the 1980s that has collapsed. Today, there is a strong correlation between shareholder payouts and borrowing that did not exist before the mid-1980s. Since the 1980s, shareholder payouts have nearly doubled; in the second half of 2007, aggregate payouts actually exceeded aggregate investment.

This next figure, a little harder to follow, uses flow-of-funds data to make the same point more dramatically.

These graphs plot corporate investment and shareholder payouts against cash flow from operations and net borrowing, respectively. Here the series are broken into three periods: 1952–1984; 1985 to the business-cycle trough in 2001; and 2002–2013. As the paper notes, the upper two panels show a strong relationship between corporate sources of funds and investment in the 1950s through the early 1980s: the points of the scatterplots fall clearly along an upward-sloping diagonal, indicating that periods of high corporate earnings and high corporate borrowing were consistently also periods of high corporate investment. The relationship between investment and the two sources of funds is still present, though weaker, in the 1985–2001 period.

But in the most recent business cycle and recovery, the correlations appear to have vanished entirely. The rise, fall, and recovery of corporate cash flow over the past dozen years is not associated with any similar shifts in corporate investment, which seems stuck at a low level of 1–2 percent of total assets. Similarly, the very large swings in credit flows to the corporate sector do not correspond to any similar shifts in aggregate investment. Turning to the lower two panels of Figure 6, which show shareholder payouts, we see at most a weak relationship with the two sources of funds in the earlier period. In the earlier period, it is payments to shareholders that are stable at 1–2 percent of corporate assets. In the most recent period, by contrast, payouts to shareholders vary much more, and appear more strongly associated with variation in cash flow and borrowing. The transitional period of 1985–2001 is intermediate between the two.

I hope you check out the full paper. Here’s the executive summary:

This paper provides evidence that the strong empirical relationship of corporate cash flow and borrowing to productive corporate investment has disappeared in the last 30 years and has been replaced with corporate funds and shareholder payouts. Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.

These results have important implications for macroeconomic policy. The shareholder revolution – and its implications for corporate financing decisions – may help explain why higher corporate profits in recent business cycles have generally failed to lead to high levels of investment. And under this new system, cheaper money from lower interest rates will fail to stimulate investment, growth, and wages because, as we show here, additional funds are funneled to shareholders through buybacks and dividends.