Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment
By J.W. Mason, February 25, 2015
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.
Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment – Introduction
Was the financial crisis responsible for the decline in business investment? It’s not clear.
During the Great Recession of 2008–2009, the U.S. experienced a severe financial crisis, involving record numbers of bank failures, the insolvency of major financial institutions, the seizing-up of interbank credit markets, and steep falls in the value of many classes of financial assets. Over the same period and subsequently, there was a major drop in business investment, including a 20 percent decline in fixed investment, in the nonfinancial corporate sector.
It has become natural to think these two phenomena are related: policymakers, economists, and journalists take it for granted that the main cause of the steep decline of business investment was the disruption in the financial system, which cut off the flow of credit to nonfinancial businesses and prevented them from financing new investment.
Yet it is hard to make sense of business investment’s deep fall and lagging recovery if the problem is access to funding. There is no question that many businesses did face tighter credit conditions during the Great Recession; small, unincorporated businesses may have been especially vulnerable to the tightening of bank lending standards. But for the corporate sector, which accounts for 80 percent of business fixed investment, it is less obvious that credit conditions are the binding constraint on investment, either during the recession or in general. The argument that an adverse shift in the supply of external funds was the main direct cause of the fall in corporate investment during and after the recession must at least account for several puzzling facts that don’t fit with such an explanation.
For the corporate sector as a whole, changes in borrowing over the last business cycle were counterbalanced by changes in payouts to shareholders, with no net effect on funds available for investment.
One striking anomaly: despite the run-up of corporate borrowing during the boom and the collapse in borrowing during the recession, the net flow of funds from financial markets to the corporate sector was no higher before the crisis than after. For the corporate sector as a whole, increases in shareholder payouts (dividends plus net share repurchases) absorbed all the increase in borrowing leading up the recession.2 And during the recession, the fall in shareholder payouts was equal to the fall in corporate borrowing. So despite the crisis in the financial system, there was no decline in the net flow of funds into the nonfinancial corporate sector. This same pattern
has persisted in the recovery.
Relative to the size of the corporate sector, fixed investment remains well below historical averages even four years a#er the official recovery began. The fall in investment occurred across the corporate sector, as opposed to being concentrated among firms with a higher probability of facing binding constraints. In particular, as shown in Table 1, large firms, firms with investment-grade bond ratings, and firms that entered the crisis with no debt, which should have been less affected by tighter credit conditions, all reduced investment during the recession by about as much as the corporate sector as a whole. Flows of funds into corporations through borrowing and earnings, and out of corporations through payouts, are now at historically high levels. From the trough of the recession in the second half of 2009 to the end of 2013, corporate investment increased by $400 billion.
Meanwhile, shareholder payouts increased by $740 billion and corporate borrowing by almost $900 billion.3 Given the strong recovery in corporate credit, it is hard to explain the continued weakness of investment in terms of problems in the financial system. (See Appendix A for more on credit constraints and the Great Recession.)
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