Looking for the Economy‐Wide Effects of Stock Market Short‐Termism

Mark Roe

Journal of Applied Corporate Finance, 2021, vol. 33, issue 4, 76-86

Abstract: To investigate the widespread claim that stock market “short‐termism” is a major drag on U.S. corporate investment and the broad economy, the author examines the evidence on long‐run trends in corporate capital investment, buybacks, and R&D. As critics of market‐driven corporate short‐termism have pointed out, U.S. corporate investment in capital equipment and other tangible assets has been falling steadily since the late 1970s and buybacks are rising. But if the story of economy‐wide decline due to short‐termism were valid, we would expect to see the following: (1) investment spending in the United States declining faster than in Europe and Japan, where large companies depend less on stock markets for capital and shareholder activists are less influential; (2) cash from all the large share buybacks bleeding out from the U.S. corporate sector; and (3) economy‐wide declines in corporate R&D spending. What the author reports, however, is that real U.S. corporate R&D spending, has been steadily rising since the 1970s and rising faster than the economy is growing. And even as corporate distributions of capital through dividends and buybacks have also been rising sharply for decades, corporate cash holdings (as a percentage of total assets), are at near record‐high levels. The explanation for such high cash holdings together with record‐high payouts—and perhaps the author's most striking finding—is that such distributions, which tend to be concentrated among larger, mature companies, are closely matched by new corporate borrowings and stock issuance—the latter often by smaller (non‐S&P 500) companies. What's more, while there's an outflow of cash from the S&P 500 from net buybacks and borrowing, there's a substantial cash inflow into the non‐S&P 500 from net stock issuances and borrowing. Finally, the fact that capital spending by European and Japanese companies—which face neither U.S.‐style quarterly‐oriented stock markets nor aggressive activist investors—has been falling more rapidly than in American companies suggests that U.S. capital markets are not a major reason for declining capital investment. And, while there's good reason for further R&D support, the author suggests in closing, reversing the U.S. government's sharply declining spending on R&D since the global financial crisis is the low‐hanging R&D fruit that should be bolstered first.

Date: 2021
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