Corporate America’s Engaged on an R&D Boom—Repurchases and Dividends

NEW YORK, NY - MARCH 06: Traders work on the floor of The New York Stock Exchange on March 6, 2013 in New York City.

Photo by Spencer Platt/Getty Images

Joshua Brown has an entertaining post about the R&D boom in corporate America. Not research and development, but repurchases and dividends. It turns out that a huge share of growth in earnings per share over the past few years has come about through a change in the denominator—the use of earnings to repurchase shares—rather than growth in earnings.

His take is this means a trickle-down recovery:

Clearly, the name of the game is enrichment for the wealthiest households and corporate executives because all of this will someday trickle-down like hard rain - mani-pedis, Michael Kors shopping sprees, Tesla Model S waiting lists, Barney’s binges etc. This is so hip hop, the one percent is making it rain on the 3 percent and Diddy’s in the hot tup spraying champagne in his own face while the camera lingers in slo-mo.

It is worth emphasizing, however, that in principle there’s nothing wrong with corporate America disgorging the cash. One way profits can turn into innovation is for a firm (say, Google) to take its search products and invest them in autonomous car research. But another way profits can turn into innovation is for a profitable firm in a boring sector (say, Safeway) to take its supermarket profits and disgorge them to wealthy shareholders, who then invest their money in capital-hungry innovative startups. This second dynamic is why, in theory, it’s better to have a progressive consumption tax that’s levied on Barneys binges than a progressive tax on investment income. You want to encourage the dividends and capital gains to be recirculated back into the investment system.

And in fact the orthodox view is more or less that it’s better for companies to disgorge the cash and then have capital be reallocated by efficient financial markets than for CEOs to keep control of the cash and direct it at their personal enthusiasms.

My view is that this is mistaken and the focus on “efficiency” ignores the real importance of fundamental innovation. But you wouldn’t want to push the heterodox view too far. If investors never got their money back on anything, you’d have very little investment. It seems to me that if you want to really understand the merits or lack thereof of the current R&D boom, you really need to look at specific firms and sectors. I hate to see a company like Apple increasing its repurchases, but Apple really seems like it could and should be doing cool stuff with its money and if it can’t think of anything cool to do, it could always be nice and pay those Chinese factory workers more. But there are lots of perfectly good companies in boring stable industries where the prospects for amazing innovation are just legitimately bleak. If your firm has no real expertise in promising markets, then running your company as well as you can and using repurchases to keep earnings per share on a growth path seems very smart.