The (over-)cost of capital A report made by Clersé (Lille 1) for CGT (Ires) Franck Van de Velde (Université Lille 1) Laurent Cordonnier (Université Lille 1) Thomas Dallery (Université du Littoral) Jordan Melmiès (Université Lille 1) Vincent Duwicquet (Université Lille 1)
Framework of the report • A research program financed by CGT • Asking for a research project on « capital cost » while lots of debates were about « labour costs » and competitivity • Tit for tat? 2
Framework of the report (2) • Report’s antithesis: – All the problems of the French economy do not stem from a lack of competitivity, coming from too high labor costs. • Beginning of report’s thesis: – French meager macroeconomic performances (shared by lots of OECD countries) may have been imputable, for a large part, to the increase in the « financial norm » for the last 30 years. 3
A cyclical history of capitalism and finance • Industrial capitalism in the 19th century… – Industrial Revolution and the Victorian compromise • …replaced by Financial capitalism in the 1920s … – Roaring Twenties and the end of the Victorian compromise. • …replaced by Fordist capitalism after WW2 … – The Great Transformation (K. Polanyi) and the Fordist compromise • …replaced by Financialised capitalism since the 1980s … – The Great Deformation (O. Favereau) and the end of the Fordist compromise • … replaced by …? 4
The parallel between the 1920s and 1980s: inequality and finance 2,0% 3,0% 4,0% 5,0% 6,0% 7,0% 8,0% 30 32 34 36 38 40 42 44 46 1913 1929 1916 1932 1919 Income Share of Top 10% Households, USA (source : Piketty) 1935 1922 1938 1925 1941 1928 Dividends Share in Households’ Income, USA 1931 1944 1934 1947 1937 1950 1940 1953 1943 1956 1946 1959 1949 1962 1952 1965 1955 1968 1958 1961 1971 1964 1974 1967 1977 1970 1980 1973 1983 1976 1986 1979 1989 1982 1992 1985 1995 1988 1991 1998 1994 2001 1997 2004 2000 2007 2003 2010 2006 2013 5
Report’s Thesis • The increase in the financial norm has provoked an increase in the over-cost of capital • The increase in the over-cost of capital has two major consequences: – A modification in wealth distribution • « If you want to understand what’s happening to income distribution in the 21st century economy, you need to stop talking so much about skills, and start talking much more about profits and who owns the capital. Mea culpa: I myself didn’t grasp this until recently. But it’s really crucial » Paul Krugman, 11/12/2012, New-York Times – A modification in capital accumulation • The investment projects which do not overcome the financial norm (15% or 30% of ROE) are not undertaken. • What is crucial is not the level of profit per se, but the use of profit (dividend distribution or capital accumulation). 6
1. What is capital cost? 1.1. Financial norm 1.2. Economic cost 1.3. Financial cost 1.4. Over-cost
1.1. Financial norm • What we call here the financial norm is the remuneration considered as « normal » or « exigible » by shareholders (i.e. sufficient to convince them to keep or buy firm’s shares rather than anything else). • In finance theory, this financial norm is viewed as the « normal » cost for capital. • One labels « cost » (for firms) what is the required remuneration of capital (for shareholders). 8
From the financial norm to the (over-)cost of capital Here, the « true » capital cost is the cost of producing productive capital. • • To this « real » cost (= economic cost of rebuilding or increasing the stock of productive capital) is added some « charges » which will compose the over- cost of capital: – These charges correspond to the « financial » cost which depend on the modalities chosen by firms so as to acquire liquid capital (to finance the acquisitions of productive capital) – Concretely, it refers to incomes taken from firms (interests and dividends), and one part of it constitutes a pure rent, with no economic justification (once we have taken into account entreprenerial risk and the administration cost of finance). • There is a double change of perspective compared to the capital cost of finance theory: – We adopt the viewpoint of firm (or the entire economy), instead of the property one. – We look at the cost supported by the firm (or the entire economy) so as to maintain its productive equipment. – We calculate what the share of unjustified financial incomes represents compared to the economic cost of productive capital. – We have to evolve from an indicator of profitability (flow on stock) to an indicator of margin (flow on flow). 9
1.2. The economic cost of capital Productive capital (Fixed Assets) Building Infrastructure Machine Equipment Brevet Software 10
1.2. The economic cost of capital Productive capital (Fixed Assets) Building Infrastructure Machine Equipment Brevet Software Wear and tear, Cost of replacement for obsolescence old equipment and cost (amortisation) of adding new equipment to increase Net investment productive capital 11
1.3. The financial cost of capital Financial Assets Owners’ Equity (shareholders’ money) Liquidities Interest and Assets Initial contribution dividends Participations Undistributed Profits dividends Successive equity issues Productive Capital Assets’ revaluations Building Infrastructure Debt Machine Equipment Brevet Interests Bank Loans Software Bonds Commercial borrowings Land 12
̶ 1.4. The over-cost of capital • The over-cost of capital is the share of (net) financial cost which does not rely on any economic justification. Entreprenerial Risk Interets and dividends paid Administration cost of finance Interets and dividends Over-cost of capital received or Pure financial rent 13
2. Take the measure of the over-cost 2.1. Compare the over-cost of capital to its true cost 2.2. Evolution of the over-cost since 1949 2.3. Timing: increase in interets then dividends 2.4. Financialisation: a regime change
2.1. The measure We simply Over-cost of capital divide the or Pure financial rent over-cost of capital by its economic cost GCF (Gross investsment) or CCA (Net investsment) 15
Method to estimate the financial cost of capital • Dividends : dividends paid minus dividends received • Interests : estimation of net real interests paid (to monitor the effects of inflation) - No real interest rates available in the data. - We compute a net nominal debt for corporations by dividing net nominal interests paid by the long-term nominal interest rate. - We apply the real interest rate for private bonds to this net debt so as to build net real interests series. 16
Evaluation of entreprenerial risk and administration cost fo finance • We melt the two in one single measure • We choose the real interest rate on loans to firms on the period 2003-2012: - Period of low rates (mean = 2%) - Supposed to compensate at least the two dimensions - We apply this rate (2%) to the stock of fixed assets. 17
2.1. Calculations for the year 2011 Estimations in Billions € Value Added Wages and GCF CCA Cost of capital Over-cost of Salaries (1) capital (2) 1004,1 514 202,3 160,1 97,4 59,2 (1) (Net dividends and interests paid) (2) (Net dividends and interests paid) minus (entreprenerial risk and administration cost of finance) Justified financial cost of capital = (1) – (2) = 38,2 Billions € 18
2.2. Evolutions since 1949 Cost and over-cost of capital 70,00% 60,00% 50,00% 40,00% 30,00% 20,00% 10,00% 0,00% -10,00% -20,00% cost of capital / GCF over-cost of capital / GCF 'justified' cost of capital / GCF 19
2.3. The back-and-forth of interets and dividends Structure of the cost of capital 70,00% 60,00% 50,00% 40,00% 30,00% 20,00% 10,00% 0,00% -10,00% -20,00% cost of capital / GCF net real interests paid / GCF net dividends paid / GCF 20
2.4. Comparisons before/after financialisation Interest rate Over-cost of used to Assets used for capital measure the the calculation compared to entreprenerial of the 1961-1980 1981-1990 1991-2000 2001-2012 Gross Fixed risk and the « justified » Capital administration cost of capital Formation cost of finance Real interest rate Over-cost of Fixed Assets -1 17 31 24 = 2% capital (1) Real interest rate Fixed Assets Over-cost of 13 30 45 39 = 2% Except housing capital (2) Real interest rate Over-cost of Fixed Assets 9 26 41 35 = 1% capital (3) Real interest rate Fixed Assets Over-cost of 16 33 48 42 = 1% Except housing capital (4) Mean for the over-cost of capital 9 27 41 35 21
A more simple indicator (Inspired from M. Husson) Share of Operating Surplus which is not invested (France) 0,5 0,45 0,4 0,35 0,3 0,25 0,2 0,15 0,1 0,05 0 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 (EBE - FBCF)/EBE 22
3. Micro and Macroeconomic consequences of the over-cost of capital 3.1. Microeconomic effects on firms’ policies 3.2. Macroeconomic effects on growth path
Micro/macro closing of the increase in the financial norm • At the micro level, shareholders’ requirements impose the new norm: « Downsize and Distribute ! » • At the macro level, they put forward a contractionary regime for investment, growth and employment 24
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