Before post, make sure that you answer the following questions and provide a link of a site that supports what you have provided for your discussion response. Question 1: By how much have companies boosted stock buybacks, dividends, and investment since 2009?Question 2:How are dividends and stock buybacks similar? How are they different?Question 3:Is the payout policy of a firm related to its investment policy? If so, how? If not, why not?Question 4:How do low interest rates affect business investment opportunities? Why might low interest rates fail to stimulate greater business investment?Question 5:Why do you think higher-yielding stocks outperform the market as a whole? Why might this relationship become “more extreme the lower rates go and the longer they stay low”?Why Aren’t Low Rates Working?
Since the Federal Reserve took rates to near zero, companies have
boosted buybacks 194%
McDonald’s and other companies are maintaining flat capital expenditures while raising
dividends. PHOTO: SAUL LOEB/AGENCE FRANCE-PRESSE/GETTY IMAGES
Updated June 5, 2016 12:55 p.m. ET
One of the great mysteries of the recovery is why low interest rates have done so little to lift
After all, that is supposed to be one of the ways monetary policy works: A lower cost of capital
makes any project more viable. But what if lower interest rates are actually hurting investment
by encouraging companies to pay dividends or buy back stock instead?
That’s the theory advanced by economist Jason Thomas of private-equity giant Carlyle Group. It
is at odds with conventional economics but has some intuitively appealing logic and supportive
He calculates that since 2009, just after the Federal Reserve took interest rates to near zero, U.S.
companies have boosted stock buybacks by 194% and dividends by 66.5%, but investment by
43%. Big energy companies have been slashing capital expenditures while boosting payouts.
Even companies without the headwind of lower commodity prices are holding the
line: McDonald’s Corp. and Eli Lilly & Co. are maintaining flat capital expenditures while
raising dividends; Verizon Communications Inc. said it plans to trim its capital budget and has
raised its dividend.
Many critics have claimed that Fed policy has hurt the economy, but they make a fuzzy
argument that exotic monetary policy such as zero interest rates and bond buying foments
uncertainty and thus undermines investment.
Mr. Thomas’s argument relies instead on basic corporate finance. Companies can choose to
distribute cash to shareholders as dividends or share repurchases or invest it in the business. In
theory, an investment that raises future cash flow also raises future dividends and should be just
as appealing as a higher dividend today, irrespective of interest rates. But Mr. Thomas says this
assumes investors don’t care whether they get their dividends today or tomorrow. In fact, he
says, investors such as retirees have a strong need for current yield and will pay a premium, in
terms of the price to earnings ratio, for a company that distributes more of its income today.
Since 1976, higher-yielding stocks systematically outperform the overall market by 0.76
percentage point when inflation-adjusted interest rates fall 1 percentage point, Mr. Thomas finds.
Moreover, the relationship becomes more extreme the lower rates go and the longer they stay
“John Bull can stand many things but he cannot stand two per cent,” Walter Bagehot, a 19th
century editor of the Economist, once said, describing investors’ need for some minimum level
When real five-year bond yields dropped 0.5 percentage point between February and May, the
Standard & Poor’s Dividend Aristocrats Index—made up of companies that increased their
payout every year for at least 25 years —outperformed the S&P 500 by 4.8%. This means that
the lower rates go, the higher a hurdle a new investment must meet to boost the stock price more
than a higher dividend.
Not all companies would respond the same way. Young companies with no internal cash flow
and tech companies that are valued more for their growth have little option or incentive not to
invest in their businesses. They would be less affected than large, mature companies with higher
depreciation expenses and cash flow.
Mr. Thomas may have solved part of the puzzle of low investment, but not the entire puzzle. He
has found that low interest rates boost the performance of stocks that pay high dividends but
hasn’t shown that dynamic influences companies’ investment decisions. While dividend
considerations might give companies one reason not to invest more when interest rates are low, it
isn’t clear how important that effect is in the scheme of things. A company may see few
promising capital projects and thus conclude it would rather return the cash to shareholders. This
wouldn’t be because interest rates are low. It would be reflecting the same forces that are
keeping rates low—too much cash chasing too few profitable investments.
Countless other factors affect the decision to invest, the most important being the outlook for
sales, which tends to benefit from low interest rates which boost consumer spending. Higher
interest rates would damp consumer spending and push up the dollar, both of which would hurt
sales and thus investment. Moreover, for companies that don’t have publicly traded shares or pay
high dividends, the traditional benefit of low rates on investment is probably still more important
than the effect on the share price.
Nonetheless, when interest rates have been so low for so long, it is worth re-examining old
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As Lawrence Summer pointed out to Paul Krugman last Sunday, infrastructure projects do not work – even
though rates are low. The burden of regualtion causes all these projects to stall and either fail or work way to
Likewise, why invest in a project that – with the burden of regualtion – will either fail or return much more
slowly. Why not buy back your stock and increase your ownership in a busienss you already know? Why not
issue dividends for cash today versus waiting out the impact of regualtion on the ability to generate future
Until the regulation is brought into check, there is little desire to invest in future projects because it is too
risky – unless it is a “no brainer”. Also, good projects have so much cash chasing them the price of the project
is so high it impacts a satisfactory return.
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