Has the ECB’s monetary policy prompted companies to invest, or pay dividends?

ABSTRACT

This paper focuses on the influence of the European Central Bank’s (ECB) monetary policies on non-financial firms. It sheds light on non-financial firms’ decisions regarding leverage, and on how the ECB’s conventional and unconventional policies may have affected them. The paper also examines how these policies influenced non-financial firms’ decisions on capital allocation – primarily capital spending and shareholder distribution (for example, dividends and share repurchases). We use an exhaustive and unique dataset comprised of income statements and balance sheets of leading non-financial firms operating in the European Economic and Monetary Union (EMU). The main results suggest that ECB’s monetary policies have encouraged firms to raise their debt burden, especially after the global recession of 2008. Finally, the ECB’s policies, especially after 2011, also seem to have led non-financial firms to allocate more resources not just to capital spending but to shareholder distribution as well.

KEYWORDS:

• ECB’s monetary policy
• capital structure
• leverage
• quantitative easing
• capital expenditure
• dividend’s policy
• shareholder yield

JEL CLASSIFICATION:

• E52
• E58
• G31
• G32

Acknowledgments

The authors wish to thank an anonymous referee and the editor for their helpful comments and suggestions on a previous draft of this article, which have enabled us to introduce substantial improvements.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ This program included buying sovereign bonds from five distressed EMU countries: Italy, Ireland, Spain, Portugal, and Greece. In November 2011, the ECB also launched the CBPP 2, which extended CBPP1, aiming to purchase additional covered bonds. After the arrival of Draghi, however, these programs were phased out – the SMP purchases ended in February 2012 and the CBPP ended in October 2012.

² According to Eurostat, non-financial firms account for nearly 58% of the total gross added value in the Euro Area and 55% of Euro Area’s gross fixed capital formation (2002–2017 average).

³ Dividends tend to be ‘stickier’ since, even if market conditions are not good, companies are likely to keep them so as not to alarm investors. Conversely, when companies face a transitory gain, they tend to distribute their windfall through buybacks rather than raise dividends and thus lift expectations about future dividends. This could explain the rise in buybacks in recent years, mainly, although not solely, in the United States.

⁴ To examine how these relationships work, we run simulations under different assumptions and investment functions. The results of these simulations suggest that under the baseline parameters, as r falls, companies tend to allocate more capital towards investment rather than on shareholders’ returns. However, as $\rho$ rises and interest rates fall, the tradeoff between investment and shareholder distribution tends to flatten. In other words, if the added value to shareholder is high enough mainly in a low interest rate environment, a further fall in the interest rate will not encourage firms to allocate more resources to investments rather than to shareholder distribution. Conversely, if$\rho$ is low, investment allocation is more likely to crowd out shareholder distribution as interest rates decline.

⁵ A good representation for the entire EMU, since their aggregate GDP accounts for roughly 75% of EMU’s GDP in 2017.

⁶ Because of data restrictions, we use the total amount that a company returns to its shareholders by distributing dividends, repurchase shares or paying back debt as a proxy of the ‘shareholder yield’.

⁷ Their model is based on Rajan and Zingales (1995) and includes five macroeconomic factors: GDP per capita, the growth rate of GDP (in constant local currency), inflation rate, interest rate, and tax rate.

⁸ All independent variables, except WACC, lag the dependent variable by one period.

⁹ The empirical evidence is also divided: Fama and French (2002) show that companies with higher profits tend to be less leveraged (thus correcting the pecking order model on this issue); whilst Frank and Goyal (2008) show the opposite.

¹⁰ The spread between 10-year weighted average of sovereign bond yields of all EMU countries and 3-month Euribor rate.

¹¹ According to Fama and French (2002), more profitable firms tend to have higher dividend payments. But Miller and Modigliani (1961) point out that rising profits do not necessarily lead to a rise in dividend payment – this will depend on other factors such as the payout ratio.

¹² Estimations were also performed by the Arellano-Bond GMM approach, providing similar quantitative results.

¹³ See Table B1 in Appendix B.

¹⁴ See Tables B2, B3 and B4 in Appendix B.

¹⁵ The list of industries is: Basic Materials, Communications, Consumer Discretionary, Consumer Cyclical, Consumer Non-Cyclical, Energy, Industrial, Information Technology, Materials, Technology & Telecommunications, and Utilities.

¹⁶ See Tables B5, B6 and B7 in Appendix B.

¹⁷ The excess capital shareholders receive could be used to reallocate funds to firms that require capital for investment. Shareholders could use the funds to increase their spending, which, in turn, could also boost economic activity. Nonetheless, not all shareholders live in the EMU, and so this spending may occur abroad. Also, shareholders could decide to invest in companies outside the EMU. These points only show that it is unclear how shareholder distribution affects the economy.

Additional information

Funding

This work was supported by the Spanish Ministry of Economy and Competitiveness [grant ECO2016-76203-C2-2-P].