Why borrow money just to give it to shareholders?

Apple Inc. earlier this week issued a number of bonds in Switzerland, taking advantage of the extremely low Swiss interest rates, to raise approximately $1.35 billion. But why is Apple borrowing money? The company is famously sitting on a large pile of savings, roughly $178 billion in easy-to-access cash or near-cash holdings. Proportionally, its reserves are roughly equivalent to the sovereign wealth fund built up by Norway. With this much cash, why borrow money at all?

The immediate answer has to do with current state of corporate taxation, but the deeper answer may be due to a shift in the management priorities at public firms.

First, the issue of taxation. Apple’s cash horde is largely held outside the United States as the company has been part of the shift toward off-shoring profits. So if Apple wants to shift money back to the United States then it would have to pay tax on these profits. And the reason Apple would want to move money back to the United States is to give it to Apple shareholders in the form of stock buy backs and dividends, as Tomas Hirst points out.

So instead, Apple is taking on debt in the form of Swiss bonds to increase its returns to shareholders. You’d think that a company would only borrow to help meet costs in the short run or finance productive investment in the long run. Yet the company has decided that its priority is to increase payouts.

Apple isn’t alone. Economist J.W. Mason at John Jay College has noted this trend can be summed up as an effort to “disgorge the cash” by public firms. Indeed, the U.S. financial system seems to favor paying out profits to investors instead of increasing investment. In a yet-to-be-published working paper, Mason shows a strong relationship between corporate borrowing and payouts, but no real relationship between borrowing and investment.

Research by University of California, Berkeley economist Danny Yagan finds a similar result. Taxes on dividends were reduced in the United States as part of a larger package of tax cuts in 2003. The idea behind the dividend cut was that it would increase corporate investment. But Yagan finds that investment didn’t increase after the cut. Instead, shareholder payouts did.

The potential harm of this shift is that the growth in U.S. gross domestic product is suffering from a lack of investment. Firms reacting to incentives from the financial system—favoring the importance of short-term stock prices over long-term share appreciation via careful investment—may result in a general reduction in investment. Data show that the non-construction net investment share of GDP has been roughly constant since the 1970s even though the price of investment goods has declined over this time. Shouldn’t we expect firms to increase investment in light of declining prices?

Now, these shareholder payouts could just be because these large public companies have run out of valuable investment opportunities. But assuming that is true, then the firm could use the would-be investment funds for purposes other than paying shareholders. It could increase the wages and salaries of its workers. Or it could reduce the price of its goods to capture more market share.

So if Mason’s thesis is correct then the financial system is giving signals to companies that may not be in the best interest of the overall economy. Corporate governance and public capital markets seem to reward companies that favor payments to capital over productive investments. And given the concerns about the pace of long-run growth, this orientation could be a wasteful choice.

February 12, 2015

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