A new paper from The Roosevelt Institute examines the “collapse” in the relationship between U.S. corporate borrowing and corporate investment into new projects or operations. Where every dollar a company borrowed prior to the 1980s would lead to 40 cents worth of investment, today more of the money is diverted into payouts for shareholders than is actually invested and there is almost no relationship between dollars borrowed and dollars invested.
In the summary blog post, they write that “very large swings in credit flows to the corporate sector [since the last recession] do not correspond to any similar shifts in aggregate investment,” while payouts to shareholders “appear more strongly associated with variation in cash flow and borrowing.” These relationships to borrowing were reversed in the pre-1980s period and crossed over each other in the 1985-2001 period most associated with significant changes to U.S. corporate governance norms and rules that tended to favor quarterly shareholder interests above all other priorities, including long-term investment.
This practice of borrowing to pay shareholders instead of borrowing to invest, as you might guess, basically means shareholders are profiting against the company’s future financial health, rather than from current (or future) returns on its previous (or current) investments. That means literally raiding the companies’ future earnings to generate payout cash now. The company will eventually have to pay back the borrowed money with interest, but it will not have gained anything from that borrowing because it was used to rain money down on shareholders instead of actually growing the company’s operations. This means companies are putting themselves deeper into a long-term hole, even as wealthy shareholders (the vast majority of American stock is held by a very small number of people with a lot of money to throw around) rake in money in the short-term.
Meanwhile, I would surmise, investment banks stand to make a lot of profits in interest — as long as the borrowing companies don’t collapse from all their unproductive loans. Down the line, a lot of American companies could have very high debt burdens while also being very underdeveloped compared to foreign competitors who invested in keeping up with the times and growing their long-term potential earnings. That will make them vulnerable to bankruptcy and other problems.
Here’s the paper’s abstract:
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.