Posted on April 5, 2021 by Florian Buschek
This is a paper by Gustavo Grullon and David Ikenberry. Here is the abstract
Despite Tobin’s q nearly doubling since the mid-1970s, the rate of corporate investment has fallen dramatically. We shed light on this paradox by decomposing q into three components relating to valuation, profitability, and asset utilization. This decomposition reveals that investment is remarkably responsive to asset utilization, more so than to valuation or profitability. This finding, combined with a pervasive and persistent decline in asset utilization over time, explains the significant drop in investment spending. Consistent with the idea that managers may be treating the stock market as more of a sideshow, we find that the impact of the valuation component of q on investment is rather modest. These empirical findings are extremely robust and hold across all G7 countries. Finally, we use this decomposition methodology to reexamine the debate around stock buybacks and find no evidence that these corporate payouts crowd out investment.
A few things stand out from this piece of research. The first is that the high and growing value of Tobin’s q is not a sign of a massive equity bubble as some might have us believe. Secondly, dividends and buybacks are buy no means evil and responsible for lack of investment.
But what is also interesting is how the US investment rate is continuously grinding lower. One reason for this is probably the role of intangibles and investing through the income statement for customer acquisition. The other might be that investment intensive production is outsourced. But there is a third reason…
… which is that corporations invest less because they don’t see those investments paying off, ie a lack of demand. This is in fact confirmed by the declining asset utilization rate in the following graph.
Did the economy become much more inefficient? Seems unlikely. You could argue that some of those investments actually need to be written down and don’t serve a useful purpose any more through technological obsolescence for example. But in this excellent interview Prof. Ikenberry mentions that they also looked at well managed and efficient companies like Walmart and saw that same trend. So it is hard to make the case that malinvestments and obsolete assets are responsible. So the answer really seems to be lack of demand. This would also explain the low rates of inflation we have seen in the recent past. After all if your assets are not at capacity you will compete on price and fight for the customer. It is no coincidence that asset utilization had its peak in this data series in the 70s coinciding with very high inflation, both falling ever since.
Finally this also points to lower inflation for longer even with the current deficit spending around the world and especially in the US. There is no way to have high inflation when the economy runs so far below capacity.