Corporate U.S. in Decline– Number of Corporations is Shrinking– Hits Lowest Level in 40 Years: Creative Destruction, or Crisis…

Corporate U.S. is shrinking– at least by one important measure: In five of six quarters to June 2016, across the S&P 500, share buy-backs and dividends exceeded retained earnings… From around 60% in 2009, the ratio of payouts and buy-backs to earnings grew inexorably, passing 100% at the beginning of 2015 and reaching a staggering 131% in the first quarter of 2016… According to Sir. Martin Sorrell; if you imagine the S&P 500 as one company, then that company ceased to grow at the start of 2015 and shrank by nearly a third in the first three months of 2016…

And, while the FTSE 100 may not have gone into reverse, a similar trend can be observed. The dividend-payout ratio has climbed from less than 40% in 2011, to over 70% in 2016… Unsurprisingly in this context, corporate investment as a proportion of GDP has continued to decline. Companies are choosing to return funds to shareholders rather than invest into operations… Yet there is no shortage of cash to invest. Companies are estimated to be sitting on more than $7 trillion of net cash worldwide– a form of corporate inertia that will continue into 2017 and beyond…

In the article U.S. Shrinking Corporate Sector by William McBride writes: The U.S. now struggles with corporate tax inversions, but this is only one of many ominous signs of a long-term decline in the U.S. corporate sector… According to a Tax Foundation Report; U.S. loses about 60,000 corporations per year and about 1 million corporations since the Tax Reform Act of 1986. IRS data shows that there were 1.6 million C-corporations in 2011. This is lowest number of traditional corporations since 1974 and 1 million fewer than there were at the peak in 1986…

In other words, in every year since 1986, roughly 40,000 U.S. corporations have disappeared from the tax rolls. And the losses have accelerated since 2006 to a rate of about 60,000 per year… Many have gone to the pass-through business sector, where profits are passed through to owners and taxed at individual tax rates that are often lower than the corporate tax rate and where there is no additional double-taxation for shareholders…

Pass-through business is subject to just one layer of tax– individual income tax; while C-corporations face double taxation due to corporate tax and shareholder taxes on dividends and capital gains… Pass-through business have grown dramatically since 1986, such that more than 90% of U.S. business are now pass-through entities. The Tax Reform Act of 1986 reduced statutory corporate tax rate and reduced the individual tax rate further, but ultimately raised taxes on corporations in other ways…

Additionally, the Act changed S-corporation and partnership rules to make them more attractive… And it appears that the Tax Reform Act of 1986 was the decisive factor that marked the start of the decline of U.S. C-corporations and beginning of an upward trend for pass-through business. S-corporations grew from 800,000 in 1986 to 4.2 million in 2011, and partnerships grew from 1.7 million to 3.3 million…

As a result, more than 60% of U.S. business profits are now taxed under the individual income tax code rather than the corporate tax code. This explains why the U.S. collects a relatively small amount of tax revenue from corporations despite having the developed world’s highest corporate tax rate… Key findings from the Tax Foundation’s Report are:

  • U.S. loses about 60,000 corporations per year and has lost about 1 million corporations since the Tax Reform Act of 1986…
  • Over time, more business have structured themselves as ‘pass-through’ entities. This allows profits to be passed through to owners and taxed at individual tax rates, which are often lower than corporate tax rate and eliminates double taxation…
  • More than 60% of U.S. business profits are now taxed under the individual income tax code rather than the corporate tax code, which explains why the U.S. collects a relatively small amount of tax revenue from corporations despite having the world’s highest corporate tax rate…
  • Outside of taxation, the traditional form of corporations often provides the most efficient business structure for large-scale projects and investments. Excessive corporate taxation and the subsequent decline of the corporate sector artificially limits this important aspect of the economy…
  • U.S. should do what the rest of the developed world has done; reduce corporate tax rate, integrate corporate and shareholder taxes to avoid double taxation, and limit corporate taxation to profits earned domestically…

In the article Risk-Aversion is Shrinking Corporate World by Sir Martin Sorrell writes: The past eight years have been an era of low inflation, low pricing power and low growth, with disruption coming from all directions– from tech startups to activist investors and zero-based budgeteers… At the same time, a great flock of geopolitical grey swans (known unknowns) clouds the horizon, draining confidence, e.g.; global rise of populism, ever-greater mistrust of institutions and corporations, intractable conflicts, i.e., migrant crisis, terrorism... In addition, slowing of major economies, potential fiscal-deficit issues, reversal of policy on quantitative easing, low-interest rates… all prey on the minds of business leaders…

This cocktail of pressures and uncertainty is not conducive to long-term strategic thinking… and the financial world’s obsession with quarterly results doesn’t help, e.g.; survey revealed that nearly 80% of executives admit that they would take actions to improve quarterly earnings at the expense of long-term value creation. Risk-aversion and short-termism is the rule in most corporate boardrooms, and although this attitude is understandable, it’s entirely wrong. Calculated risk-taking, in the form of investment, is the lifeblood of any business that wants to be successful in the long-term…

Indeed, some economists can imagine a future where even the most valuable companies will opt-out of public markets… According to Kathleen Kahle, Rene Stulz; not only is number of public corporations  in decline, there is growing inequality in economic wealth of those that remain, e.g.; in 2015, 35 corporations accounted for 50%  of all assets of public corporations and 30 accounted for 50% of all net income… While in 1975, numbers were 94 accounted for 50% and 109 accounted for 50%…

Another striking change: In 1980, institutional ownership of public corporations averaged 17.7%; today it’s over 50%. Also, average age of public corporations increased from 12.2 years in 1995, to 18.5 years 2016… This reflects an increasing unwillingness of companies to go public, and there are very good reasons, e.g.; capital investment is easily available, and companies feel no need to put up with the extra regulation and scrutiny that come with being publicly listed…

Overall there seems to be a loss in the sense of purpose for being a public company… According to Kahle and Stulz; public corporations appear to lack ambition, proper incentives, opportunities… They are returning capital to investors and hoarding cash rather than raising funds to invest more… Hence, shrinking numbers of public corporation is not just problem for business leaders but also one for world at large…