Superstar firms benefit more than others from cheap credit

A flurry of research since investigating such superstar firms has set off a vigorous debate over the role of antitrust enforcement in facilitating their rise, whether their rise is more apparent than real, and to what extent they contribute to overall wage inequality. add to. History will show that the pandemic has made the ‘Matthew effect’ of major companies even more dominant.

However, Furman and I paid little or no attention to the role of low interest rates in all of this. An interesting new National Bureau of Economic Research working paper, ‘Falling Rates and Rising Superstars’ by Thomas Krone, Ernest Liu and Atif Mian of Princeton University and Amir Sufi of the University of Chicago, does exactly that.

Krone et al take data from 1980 to 2019 on a wide range of companies and assess the effects of interest rate changes on the top 5% of companies within each industry relative to the others. The key finding is that “falling rates, especially when rates approach zero, disproportionately benefit ‘superstar’ firms.” These findings are based on whether companies are ranked by market value, earnings or revenue. In particular, the market value of a superstar firm relative to other firms rises when interest rates fall. The authors measure the rise and fall of interest rates separately and find largely symmetric results: a fall in rates benefits the major firms, and a rise in rates causes a decrease in their relative market values. The effect, furthermore, “snowballs” in the sense that a given drop in rates has a major impact on the superstar when interest rates start from a low point; So a drop of 2% to 1.5% has a bigger impact than a drop of 5% to 4.5%.

What is the reason for this differential market reaction? Several factors appear to contribute. First, when interest rates fall, superstar firms experience a large drop in the cost of borrowing. If the short-term interest rate is 2% and then falls 10 basis points (1.9%), then borrowing costs for industry leaders drop by 15 basis points relative to other companies. When the initial rate is close to zero, a drop of 10 basis points produces an even bigger relative change: borrowing costs then drop 24 basis points for Superstars, as they do for others.

Second, superstar firms respond to a relative decline in borrowing costs by issuing more debt, and once again the effect is larger if the initial interest rate is already low. When rates start near zero, a drop of 10 basis points in short-term rates is associated with a 5% increase in superstar debt relative to industry adherents.

Finally, leading companies use additional debt to not only buy back more shares than others, but to expand investments and mergers. When interest rates start near zero, a drop of 10 basis points is associated with a 0.4 percentage-point increase in capital expenditures and a 1 percent increase in cash acquisitions relative to total assets for major firms compared to followers.

As the authors concluded, interest rate declines lowered the borrowing costs of industry leaders, which can increase additional debt financing, increase leverage, borrow to repurchase shares, boost capital investment, and acquire acquisitions. Take advantage of the low cost of acquisition. The findings provide empirical support to the idea that extremely low interest rates may be a culprit in explaining the rise of superstar firms in the US economy.

If the new findings are confirmed by other research, they would have three major implications. First, they directly link US Federal Reserve policy to the competitive structure of industries, suggesting a closer relationship between monetary policy and the superstar phenomenon than previously appreciated. Second, they raise the question of whether similar effects are seen in other countries. The fall in interest rates has, after all, been global. Whether similar effects are observed elsewhere would contribute to the debate over the role of various factors, including antitrust enforcement, in the rise of superstars.

As Robert Rubin, Joseph Stiglitz and I emphasized earlier this year, interest rates remain uncertain, despite the best efforts of policymakers and central banks. Low rates contribute to the disproportionate growth of superstar firms, but no one really knows how long the era of low rates will last.

Peter R. Orszag is the Chief Executive Officer of Financial Advisors at Lazard.