At Bloomberg Noah Smith has a post that is so important it should be required reading. Here’s the meat of it:
How much of this increase in market value was due to rent extraction, or to the expectation of future rent extraction? Economists Daniel Greenwald, Martin Lettau and Sydney Ludvigson believe they have an answer: Most of it. In a recent paper, they built a model of the economy in which the value created by businesses could be arbitrarily reallocated between shareholders and workers. They found that redistribution from workers to shareholders accounted for 54% of increased stock wealth. Falling interest rates, rising investor appetites for risk and economic growth comprised the remaining 46%.
[…]
But this leaves the question of how shareholders have managed to extract increasing rent from the economy. In a healthy economy, competition should get rid of rents, because new companies will enter the market and vie for a slice of that pie, offering lower prices and higher wages until the rents mostly disappear. In some industries, like semiconductors, this still happens.
But in most industries, economists Germán Gutiérrez and Thomas Philippon believe, this process has broken down. In a new paper, they attempted to measure how much new business entry responded to the market opportunity available in an industry. Gutiérrez and Philippon used a measure called Tobin’s Q, which represents the ratio of a company’s market value to the book value of the company’s assets. When Q is high, it should mean that new competitors have an opportunity to come in and take some of the profits in that industry, thus reducing existing companies’ price premium and bringing Q down. Indeed, the authors found that this was common up until the late 1990s. But after 2000 — right around the same time that profits started to rise to unprecedented levels — the relationship broke down. High Q levels no longer seem to attract new market entrants.
The most credible explanation for this is that the companies are able to lobby their way into regulations more favorable to themselves. That’s the “crony capitalism” I complain about so much. Their main form of business investment is lobbying and the ROI is great.
What can be done about it? I think that we should be breaking up big companies just because they’re big and prohibiting large foreign companies from doing business in the U. S. outright (a frequently-encountered excuse for corporate size is to be able to compete with large foreign competitors).
Hold on there. Because I do private equity analysis, I’m a bit rusty. But I can tell you that in the private investment world you would be laughed out of the board room if you started talking Q.
Now admittedly, market values to replacement cost of physical assets are creatures of public markets almost by definition. But if memory serves:
1) speculative activity is a key to elevating market values, pretty much destroying the value of Q’s original implications.
2) in that regard, I believe Qs peaked in the late 90’s, no doubt triggered by dot.com speculation. (low asset intensity companies; speculative market multiples make Q go into the toilet as analytical tools.) And Q returned to more historical levels afterwards. It looks like the authors are trying to attribute different dynamics for the decline.
3) and although I am completely sympathetic to criticism of crony capitalism, I think valuation issues dominate regulatory capture, as well as an old theme of mine: declining asset intensity in the economy.
That, too, is a result of policy—environmental regulations, labor regulations, zoning, taxes that are not levied on services, taxes levied against brick-and-mortar businesses that are not levied against online businesses with which they compete, etc. have that consequence. Of itself that wouldn’t bother me but not taking any steps to remediate the harm done by the policies does.
You bet. I doubt there are too many commenters or lurkers who would defend crony capitalism here.
I just think these characters have produced academic mumbo jumbo thinly veiled in 40-50 year old has been statistic. I defy anyone to really define and determine with any real precision capital stock values. GAAP tries, but its miserable. Issues No 1 and 1a are intellectual capital and nameplate capacities.
I generally agree with Drew’s comments about smaller companies, but the big ones are problematic. They generally write their own regulations (via lobbyists) so that they minimize competition and they dottier best to extract rents, as was noted in an earlier piece. That said some competition still exists and I can see some advantages in scale. So I have mixed feelings about eliminating. However, where we really have issues are with he big financials. Break them up or regulate them to infinity if you can. (Not really happening since they now have too much influence but one can hope.)
Steve
The advantages of scale evaporate far earlier than most think. Other than for lobbying, that is.
“The advantages of scale evaporate far earlier than most think. Other than for lobbying, that is.â€
It’s probably fodder for other posts, but I think that’s overstated. It goes far beyond spreading overheads, primarily diversification issues. We are about to become proud owners of a a half billion EBITDA packaging company with operations in the US, SAmerica, and Europe. Operational, product, market and currency exposure diversification all come with it. But most importantly, key customers (think the likes of Unilever) demand the size and scope.
I think I’m talking about a slightly larger scale than that. Yes, a $1 billion company has considerable advantages over a $10 million company. But a $10 billion dollar company doesn’t have that many advantages over a $1 billion company and the advantages a $100 billion company has over a $10 billion are negligible. Other than in rent-seeking.
As I said, it may be more for another post or series of posts, but could you just put down some dot points on what you see as business advantages or disadvantages that melt away in the sizes you cite.
We also get into issues of liberty, and into assumptions that the very same company that seeks rents through the political system at $100b wouldn’t do so at $10b. Or during the breakup. And the mechanics of a breakup would be horrible – worse than sausage making – and inevitably lead to court challenges right up to the Supremes. I wonder if attacking the political system (power) wouldn’t be easier.
For example, the Facebooks of the world are no doubt inviting regulatory interference so they can write the rules. How do you break them up to avoid it? I smell another fine mess, Stanley.
Sure. Purchasing power. I have seen at first hand that the discounts offered to $100 billion dollar companies are the same available to $1 billion companies. Organizational support. My present employer is probably a $100 million company, a small to medium-sized company. It has all of the disadvantages of a small company and all of the disadvantages of a big one with none of the advantages of either.
I think that once a company is able to operate regionally or even nationally rather than just locally most of the advantages of size have already been realized and that is easier than ever before.
What I think you’re saying is that we shouldn’t allow companies to get big enough to be influential at the national level and that we should institutionalize the process of reducing companies in size rather than it being an incident. I agree. Breakin’ up is hard to do. That doesn’t mean it doesn’t need to be done just that it is more painful than it otherwise might have been.
In health care there are advantages to getting up over the $1 billion mark. Somewhere in the $3billion-$5 billion mark is where you can begin to put yourself at risk and make it work. Before that having your own insurance product is iffy. It is also somewhere around that point where your network can begin to offer a fairly comprehensive product, especially for pediatrics.
Steve
I’m not arguing that we should break up $1 billion companies. Or even $5 billion companies. I’m arguing that we should break up companies that are greater than $100 billion in size. The question is whether a $100 billion company has advantages of scale that a $50 billion company doesn’t. I’m skeptical.