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The Real Reason Companies Aren't Investing, Round Two

Investors don–t expect robust returns, and businesses, unfortunately, are complying.
Vincent Ryan, | US
August 9, 2012

If you're Jamaican sprinter Usain Bolt, it makes perfect sense not to run each of your Olympic races at top speed. In the qualifying rounds of the 200 meters, for example, when Bolt is plenty ahead, he decelerates in the last 50 meters, because there's no reason to risk injury - he doesn't need to blow away the field, just finish among the top three to advance to the next round.

In a sense, U.S. businesses are following the same philosophy. But in their case there's no final race, no point at which they are willing to lay all or most of it on the line, like Bolt did this week in his 100 meter race. Instead, we have endless qualifying rounds in which 50% effort by a company - or even less - passes muster.

I'm talking of course about the return on investment that companies are earning, the yields they are producing for their shareholders, and their lack of aggressiveness in growing their businesses.

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Managements and boards are being perfectly sensible. In a near-zero interest rate environment, betting big on an internal growth project or a large acquisition is crazy. Shareholders aren't looking for a homerun, they just want something more than the paltry yields on government Treasuries, which in some cases are negative.

I don't have the ability to look inside the minds of all CFOs; from a macro perspective all I have to go on are the actions companies are taking. And their actions are saying, "Our owners (shareholders) have set the bar low, and we're happy to jump just high enough to clear it."

For a public company, jumping just high enough means sating shareholders with a dividend, instead of investing funds in a project that will increase the value of the firm and its equity. According to CFO Journalthe number of S&P 500 companies paying dividends hit 402 this year, the highest since December 1999. The amount of money paid out as dividends is forecast to be a record $275 billion for 2012.

The owners of corporations are happy to get a 2% yield on their shares. Management need not take the cash spent on a dividend and instead allocate it to a project that could earn 10% but comes with the commensurate risks. (At least that's what a portion of the equity markets seems to be saying.)

What's permitting this abundance of caution? The low cost of debt.

Booz Allen Hamilton recently declared a $6.50 special dividend to its shareholders partly financed by debt. And why not, when Booz is paying about 3% on its loans? Cheap debt is in abundance, especially in the bond markets. Blue-chip companies are borrowing at rates once only achievable by sovereigns. And that money is going to run for a long time if issuers wish it too - 21.5% of industrial volume last quarter carried maturities of 15 years or more - the highest share since mid-2007, says Fitch.

In the meantime, companies are avoiding the more volatile, dearer equities markets. Secondary stock offerings are down 23% as of the end of June, at $77 billion, according to the Securities Industry and Financial Markets Association. Part of the problem is that share-price movements are dictated by the news out of Europe or U.S. macroeconomic forecasts. That makes it hard to stand out to investors - better to run along with the pack.

Bond markets are simpler. Investors just want companies to earn enough to pay back the coupon and preserve their principal. And companies are complying - corporate debt is as much a safe haven as any other instrument now.

Who or what is to blame for a situation that is not only threatening the competitiveness of U.S. industry but strangling the economy? The hangover from the financial crisis? The Federal Reserve? (Low interest rates are killing the real economy, as we have just demonstrated.) The mess in the euro zone?

We could blame boards of directors and members of the C-suite, but really they're just trying to appeal to investors. Maybe this is an occasion for rejoicing - the "principal-agent problem" is finally solved. Executives are no longer swinging for the homerun. Their interests are aligned with many of their stakeholders, in a strange, passionless embrace of low-return, low-risk investment.

For an economy starved of innovation and reasons to cheer, all this is unwatchable. U.S. companies are not pacing themselves for some more meaningful race in the future. Indeed, it appears that they're not even running to win. And that's not track and field, it's badminton.