How Superstar Firms Win Big From Low Interest Rates
(Bloomberg Opinion) -- Low real interest rates and the rise of so-called superstar firms are two of the most prominent features of the macroeconomy over the past decade. A new analysis suggests the two are intricately related, highlighting the interaction between monetary policy and the industrial organization of companies.
In 2015, Jason Furman and I highlighted a relatively new development: a dramatic increase in the dispersion of capital returns across companies, with industry leaders seemingly pulling away from others within the same sector.
Since then, a flurry of research has examined such superstar firms, with a vigorous debate occurring over the role of antitrust enforcement in facilitating their rise, whether their rise is more apparent than real, and to what extent they add to overall wage inequality. History will likely show that the pandemic reinforced the “Matthew effect” of leading companies becoming even more dominant.
Furman and I, however, paid little or no attention to the role of low interest rates in all this. An interesting new National Bureau of Economic Research working paper, “Falling Rates and Rising Superstars,” by Thomas Kroen, Ernest Liu and Atif Mian of Princeton University and Amir Sufi of the University of Chicago, does precisely that.
Kroen et al. examine data from 1980 to 2019 on a wide array of companies, and assess the effects of a change in interest rates on the top 5% of companies within each industry relative to others. (It is a purely econometric paper, with no individual companies named.) The key finding is that “falling rates, especially as rates get close to zero, disproportionately benefit ‘superstar’ firms.” These findings hold regardless of whether the companies are ranked by market value, earnings or revenue.
More specifically, the market value of superstar firms rises, relative to other companies, when interest rates decline. The authors separately assess increases and decreases in interest rates and find largely symmetrical results: A decline in rates benefits the leading firms, and an increase in rates reduces their relative market values. The effect, furthermore, “snowballs” in the sense that a given drop in rates has a larger impact on the superstars when the interest rate starts from a lower point — so a decline from 2% to 1.5% has a larger effect than a decline from 5% to 4.5%.
What causes this differential market response? Several factors appear to contribute. First, when interest rates fall, superstar firms experience a larger decline in borrowing costs. If the short-term interest rate is 2% and then falls 10 basis points (to 1.9%), the cost of borrowing for industry leaders declines by 15 basis points relative to other companies. When the initial rate is closer to zero, a decline of 10 basis points produces an even larger relative change: Borrowing costs then drop by 24 basis points more for superstar companies than they do for others.
Second, the superstar firms respond to the 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 out close to zero, a decline of 10 basis point in short-term rates is associated with a 5% increase in debt for the superstars relative to industry followers.
Finally, the leading companies use the additional debt not only to buy back more shares than others, but also to expand investment and mergers. When interest rates start near zero, a decline of 10 basis points is associated with a 0.4 percentage point increase in capital expenditures and a 1 percentage point increase in cash acquisitions relative to total assets for leading firms, compared with followers.
As the authors conclude:
A decline in the interest rate disproportionately lowers the cost of borrowing of industry leaders, who take advantage of the lower cost of borrowing to raise additional debt financing, increase leverage, repurchase shares, boost capital investment, and conduct acquisitions … 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 U.S. economy.
If the new findings are corroborated by other researchers, they will have three important ramifications. First, they directly link Federal Reserve policy to the competitive structure of industries, suggesting a closer connection between monetary policy and the superstar phenomenon than had been previously appreciated.
Second, they raise the question of whether similar effects are seen in other countries. The decline in interest rates, after all, has been global. Whether similar effects are seen elsewhere would contribute importantly to the ongoing debate over the role of different factors, including antitrust enforcement, in the rise of the superstars.
Finally, as Robert Rubin, Joseph Stiglitz and I emphasized earlier this year, despite the best efforts of policy makers and central banks, interest rates are fundamentally uncertain. Low rates seem to contribute to the disproportionate growth of superstar firms — for better or worse — but neither they nor the rest of us know how long the era of low rates will persist.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Peter R. Orszag is a Bloomberg Opinion columnist. He is the chief executive officer of financial advisory at Lazard. He was director of the Office of Management and Budget from 2009 to 2010, and director of the Congressional Budget Office from 2007 to 2008.
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