A Critical Long View of Capital Markets and Institutions: Realized Returns from Corporate Assets, 1950-2003

Abstract

It is often taken for granted that: 1) capital markets and institutions allocate funds to firms where realized returns on real assets are highest; 2) the net gains to the economy from investments by corporations have improved in the last 30-50 years due to innovations and better risk management techniques in the financial markets; and 3) the agency cost-reducing role of markets and institutions ensures that real assets funded with external funds would earn higher returns. However, corporate real assets are long lived, and realized returns have to be tracked over a long period to verify these assertions. We perform large-scale calculations of the realized returns on real assets to all firms available in the Compustat database for periods of 10, 20, 30, 40, and 50 years. Our methodology relies only on cash flow between the firms and all their fund providers. In particular, we focus on capital markets, institutions and non interest bearing liability holders. It circumvents the potential problem in using market expectations of future cash flows if markets are inefficient over long periods as suggested by Shiller (1981). We found several new and surprising results. Returns on real assets by corporations derived from actual cash flow over long periods are, on the whole, lower than expected by the fund providers. They suffer a long-term decline, and have been below the yields of 10 year Treasury bonds since 1973. Real assets that received more external financing (from capital markets and institutions) actually report even lower realized long-term returns. These unexpected results may stimulate fresh debate on the roles and long-term performance of capital markets and institutions.