Corporate Reinvestment

Peter Van Doren

The Washington Post recently reported on an analysis by Oren Cass of corporate profits and their division between dividends, stock repurchases, and reinvestment. The report argues that profits are being dispersed to shareholders through dividends and stock repurchases rather than reinvested. The result is reduced economic growth and fewer opportunities for American workers.

Two papers I review in Regulation examine the issue. The first paper confirms that payouts to shareholders (rather than retention of earnings within the firm) are larger now than in the past. In the 2000s, annual aggregate inflation‐​adjusted payouts were three times their pre‐​2000 level and increased as a percentage of assets (2.7% for 1971–1999 versus 4.1% for 2000–2017) and as a percentage of operating income (18.9% for 1971–1999 versus 32.4% for 2000–2017).

The payouts are higher because firms now earn more and pay out more of what they earn. About 38% of the increase in payouts is from higher earnings and 62% from a higher payout rate, which is exclusively from stock repurchase instead of dividends. Dividends average 14.4% of operating income from 1971 to 1999 and 14% from 2000 to 2017. Net stock repurchases averaged 4.8% of operating income before 2000 and 18.3% from 2000 to 2017.

Higher payouts are the result of changes in the values of variables that historically have explained corporate payouts: increases in firm age, size, and cash holdings, and decreases in leverage. A traditional econometric model of payouts is estimated with data on these four variables with data from 1971–1999. The results are then used to predict current payouts. The model predicts that real aggregate payouts in 2017 should have been $784 billion; actual payouts were $734 billion, actually slightly less than predictions. But firm age, size, cash holdings and leverage continue to predict current corporate payouts.

The lifecycle model of payouts predicts that younger firms should invest heavily and have no payouts. Profitable older firms have fewer growth opportunities, and thus should pay out the funds they cannot invest profitably. We therefore expect the payout rate to increase with firm age and size. Thus, the changing composition of U.S. firms toward older firms explains the increase in payouts.

The implication of the Oren Cass analysis is that firms are investing less in order to pay out more to shareholders: firms are destroying the economy in order to reward the rich. The authors confirm that capital expenditures as a percentage of assets have decreased over time but the decrease has occurred similarly among firms that payout the most versus those that pay less and similarly among those firms that payout something versus those that payout nothing. There is no relationship between firm payouts and capital expenditures. Nonpayers use the cash released by lower capital expenditures to increase R&D. In contrast, payers (and especially the top payers) increase R&D spending, but by less than the decrease in capital expenditures; thus they have an increase in free cash flow that enables them to make larger payouts.

The second paper examines the transformation of the relationship between Tobin’s q (equity market value divided by book value) and capital flows. Capital flowed into industries with higher Tobin’s q over the period 1971–1996. But from 1997 to 2014, capital flowed out of high‐​q industries. The change is from the repurchase of stock after 1997.

These results make little sense if high‐​q industries are the ones with the best investment opportunities and competition leads them to expand through additional investment up to the point at which those opportunities for expansion no longer exist. However, these results do make sense if the dominant firms in high‐​q industries draw rents from scarce assets, so that their high q reflects their ability to collect rents rather than an investment opportunity.

Reinvestment in mature industries with those characteristics would actually reduce returns and productivity and ultimately hurt workers. Instead, such firms should fund payouts that can be used by investors to invest in new firms in which the funds assist long‐​term economic growth and worker incomes.