Corporate valuations relative to assets, as well as corporate
profits, have seen a sustained rise in the United States over the
last three decades. Do these increases signal that U.S. firms are
extracting excessive profits? While a dynamic, competitive economy
rewards innovative firms with high profits, sustained
aggregate profits suggest, instead, that firms are able to
get away with higher prices because competition is limited. With
limited competition, they earn supra-normal profits called
“economic rents.” Sometimes firms engage in political
“rent-seeking”—lobbying for regulations that
provide them sheltered markets—rather than competing on
innovation. What do today’s high corporate profits imply for
economic dynamism and inequality?
A large literature associates regulatory rents with diminished
dynamism because of wasteful rent-seeking that creates barriers to
entry or diverts talent from productive endeavors. In addition,
inequality might result in part from political rent-seeking, and
rising corporate valuations might generate greater wealth
inequality and the rise of a rentier society.
Yet not all rents arise from political rent-seeking nor do all
rents imply social waste. For example, firms can earn rents on
innovations. These rents constitute an important incentive to
innovation. Generally, firms capture returns on intangible
investments as rents, that is, as supra-normal profits. This
includes returns on R&D, on “brand capital,” and on
organizational investments. Thus, understanding the reason for
rising valuations and profits is crucial for evaluating the
implications of these trends.
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My research explores the roles of intangible investments versus
regulatory rents in accounting for the recent rise of corporate
valuations and profits.
To do so, I argue that the complexity of regulation is a proxy
for a wide range of rent-seeking activities—those regulations
that are most contested tend to become the most complex. Using a
new index of regulatory restrictions, along with measures of
election spending and lobbying as additional proxies for political
rent-seeking, I reject the view that industries with the greatest
rents attract the greatest regulation. Instead, causality flows
from regulation to higher corporate valuations. Nor does regulation
tend to reduce profits by burdening firms with compliance costs.
While self-interested regulators and politicians may well impose
costs on firms (the “tollbooth” view), firms benefit
from regulations overall.
These benefits, moreover, appear to be large. Regulation
corresponds to an increase in corporate valuations of about $2
trillion in the sample. Regulation and campaign spending are
responsible for an increase in markups on the order of 1 percent.
That corresponds to about a $200 billion increase in transfers from
consumers to firms each year. Most of this effect occurs in five
heavily regulated industries: chemicals, including pharmaceuticals;
petroleum refining; transportation equipment; electric, gas, and
sanitary utilities; and communications.
Several tests suggest that the link between industry regulation
and corporate profits is causal, flowing from regulation to
profits. This is consistent with regulatory capture. While
regulation might be initiated with the goal of fixing market
failures or by government bureaucrats and politicians seeking to
extract rents, the net effect is to increase rents for publicly
listed corporations.
Thus much of the growth in corporate valuations and profits
since 1980 can be accounted for by growing investments in
intangibles, especially investment in R&D. But it appears that
an even larger share of the rise in valuations and profits can be
accounted for by factors associated with growing regulation and
political activity, especially after 2000.
Some observers have highlighted the possible role of increasing
industry concentration in generating economic rents. Using two
different measures of concentration, I find only a weak
relationship with profits that is neither statistically nor
economically significant. However, that finding might simply mean
that such broad industry measures do not capture the main sources
of rents, which might occur in local or regional markets or in
differentiated product niches or might be based on scarce
government-supplied inputs.
Several qualifications affect the interpretation of these
findings. First, regulatory rents are not substantial in most
industries; they are highly concentrated in a small number of
industries. This has implications for the dispersion of firm
profits that might be related to rising interfirm wage
inequality.
Second, this study only looks at publicly listed firms. The
effect of regulation might be different on private firms,
especially small firms. Indeed, if rents are created via barriers
to entry, one might expect large firms to benefit and small firms
to be harmed.
This raises an additional limitation. While this study finds a
large, causal effect from regulation and political activity, it
does not identify the actual mechanism at work. Do rents rise
because of barriers to entry or because of a diversion of resources
to rent-seeking or something else?
This is important for understanding the implications of the rise
in regulatory rents and their normative significance. Not all
rent-seeking activity is socially wasteful; clinical trials for
drugs and pollution compliance costs may benefit society. But even
in these cases, rising economic rents may dampen economic dynamism,
creating social costs not considered in typical cost/benefit
calculations of new regulations. The rising significance of
election spending and lobbying in the empirical analysis makes
these concerns particularly worrisome. In the long run, if
regulatory rent-seeking decreases economic dynamism and increases
economic inequality, the harm might be much greater than current
static losses of consumer welfare.
Note
This research brief is based on James Bessen, “Accounting
for Rising Corporate Profits: Intangibles or Regulatory
Rents,” Boston University School of Law Law & Economics
Working Paper no. 16-18, May 2016, https://www.bu.edu/law/working-papers/accounting-for-rising-corporate-profits-intangibles-or-regulatory-rents/.
