Why Lower Growth, Higher Corporate Profits?

First-quarter economic growth wasn't as bad as expected, yet corporate profits were much better than expected. So what are corporations doing with their profits rather than investing in future growth?

The second revision to first-quarter GDP came in at -0.2 percent. Exports were near the top of the negative side, reflecting the strong dollar's negative effect on foreign demand. A rise in imports was the quarter's biggest negative, and consumer spending on services the biggest positive. Personal consumption (PCE) grew 2.1 percent annually, reflecting happier consumers, and residential investment surged to 6.5 percent as growing new and existing home sales show the housing market in recovery.

This is while corporate profits continued their record ways, up 9 percent annually. So where are the profits going, with most Fortune 500 corporations paying much less than the nominal federal tax rate of 35 percent? Analyst estimates show that total S&P 500 capex spending (i.e., capital expenditures) could dip 11 percent to $641.6 billion in 2015 from actual 2014 spending of $718.1 billion, marking the lowest level since 2011's $591.5 billion, according to Thomson Reuters data.


Graph: Econoday

"U.S. corporate spending on capital projects could fall this year to the lowest level since 2011, with steep reductions by the energy industry and companies in other sectors cutting spending amid broad concerns about global growth," said the Thomson Reuters report. That could translate to lower job growth and weakness in the technology and industrial companies that typically benefit from capital spending.

So then what do corporations do with their excess cash? S&P 500 companies still have record levels of cash on their balance sheets -- somewhere between $3.5 trillion and $5 trillion, according to the St. Louis Fed -- as spending on stock buybacks and dividend payments has come at the expense of capex for many companies.


Graph: St. Louis Fed

In fact, this has been to the detriment of both the profits and the growth of those companies that have hoarded their cash reserves, according to a Deloitte LLP report, "The Cash Paradox: How Record Cash Reserves Are Influencing Corporate Behavior."

"Critically, a divergence in share price between the cash hoarders and the spenders has emerged," says Iain Macmillan, partner and head of M&A and New Growth for Deloitte LLP in the UK. "Since 2000, the share price performance of the small cash holding companies has outperformed their large cash holding counterparts, growing by an astonishing 632 percent compared to 327 percent for their larger cash holding counterparts. Remarkably, the gap widened even more after the financial downturn. This suggests that in the long run, the markets are rewarding companies that take a more bullish attitude toward growth."

That should be a no-brainer for corporate heads. So it seems that cash buybacks and dividend payments are not the way to spend profits to increase market share and overall growth. Corporate CEOs now make, on average, 300 times their employees' average income, much of it in stock options that tend to increase in value with stock buybacks and increased dividends.

It is no longer a secret that CEO compensation has reached stratospheric levels. The AFL-CIO union website catalogues those compensation levels -- with the majority from stock holdings rather than outright salaries. JPMorgan Chase CEO Jamie Dimon earned just a $1.5 million salary in 2014, but more than $20 million in stock compensation, for example.

The Economic Policy Institute revealed Monday that the average total compensation of CEOs at the 350 largest firms was $16.3 million in 2014, roughly 303 times the average pay of their workers, reports CNN. The divide between CEO and worker pay has increased every year since 2009, when CEO salaries dropped to 196 times the average worker's salary, according to the report. While CEO pay has risen 997 percent since 1978, the average employee pay has grown 10.9 percent.

So why not raise their employees' wages and benefits with some of the cash hoard--for instance, retirement and healthcare benefits? Then, instead of enriching themselves, those CEOs would see an increase in demand for their products and services.

This is standard aggregate demand theory, and once again obvious to those concerned with our poor economic growth record, economic growth that has been steadily declining since 1980. Consumers make up some 70 percent of economic activity these days, ergo if corporate CEOs paid their employees more, it would certainly benefit corporate bottom lines, as well.

Harlan Green © 2015

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