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Low real rates of interest and the rise of so-called superstar firms have been two major features of the US economy 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.

A flurry of research since has examined such superstar firms, setting off a vigorous debate 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 take data from 1980 to 2019 on a wide array of companies and assess the effects of interest-rate changes on the top 5% of companies within each industry relative to others. 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. 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 superstars than they do for others.

Second, 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, leading companies use 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 US economy.

If the new findings are corroborated by other research, they will have three major ramifications. First, they directly link US 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 to a debate over the role of different factors, including antitrust enforcement, in the rise of superstars.

As Robert Rubin, Joseph Stiglitz and I emphasized earlier this year, despite the best efforts of policymakers and central banks, interest rates are uncertain. Low rates seem to contribute to the disproportionate growth of superstar firms, but nobody really knows how long the era of low rates will persist.

Peter R. Orszag is chief executive officer of financial advisory at Lazard.

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