Changes in the Incentive for "Breadth"

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Changes in the Incentive for "Breadth"

Postby blairfix » Sun Jan 11, 2015 4:27 pm

This post represents a bit of a break through in my research. For a long time, I've been trying to understand the structural transition that occurred after 1970. Around this time, dominant capital suddenly stopped expanding its share of employment. The era of accumulation through breadth came to a close.

Interestingly, this transition nicely matches changes in per capital energy consumption.
Breadth.png
Breadth.png (133.35 KiB) Viewed 1454 times


But the big question is why? For a long time, I have been puzzled. Below are some results that shed light on the issue.

Corporations do not care about energy consumption ... nor do they really care about employment. Using energy and hiring workers is a means to an end -- profit. If a corporation can make a profit without hiring workers, it will do so. So-called patent trolls are a good example of this (http://en.wikipedia.org/wiki/Patent_troll). Patent trolls hold a patent but do not manufacture any product. They simply collect royalties from others who do.

This then begs the question: how has the relationship between profitability and employment changed over time? To investigate, I looked at the 400 most profitable Compustat corporations from 1950-2013. I then looked at the annual correlation between profit levels and the number of employees within this group. I also looked a correlation between capitalization and employment, and capitalization and profit.

Here are the results, where r-squared values are plotted as a time series:


K v E.png
K v E.png (262.38 KiB) Viewed 1454 times


Between 1950 and the late 1960s, a strong correlation exists between employment and both profitability and market capitalization. In other words, increasing employment was a reliable way to increase profits. However, things all started to change by 1970, when the correlation declines precipitously. By 2013, there is almost no correlation.

There is no longer any relationship between profitability and employment. The message: breadth is no longer a reliable way to increase profits.

As expected by the CaSP framework, throughout the whole period, market cap and profit remain strongly correlated.

Of course, this evidence leads to another question: why is larger employment no longer more profitable?
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Re: Changes in the Incentive for "Breadth"

Postby blairfix » Sun Jan 11, 2015 9:40 pm

Some methodological clarifications based on suggestions from Jonathan:

1. Data is for Compustat firms with headquarters in the US.
2. Each point represents a correlation of 400 observations (i.e. where each observation is the data from a specific firm Top 400 firm in the given year)
3. Correlation is between annual levels of employment, profit, and market cap ... not rates of change

Note that change the ranking methodology affects results. If either market cap or employment levels are used to rank the top 400 corporations (rather than profit) the long-term trends remain similar, but short-term trends are different.
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Re: Changes in the Incentive for "Breadth"

Postby dtcochrane » Tue Oct 27, 2015 5:57 pm

My analysis of GE would seem to confirm exactly this trend, in its specific case. I'll be talking about this during my presentation.
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