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Raising Capital In The Global Economy

1672 words - 7 pages

1. How is raising money in U.S. stock markets more difficult than in the rest of the world?Even if productivity growth has risen, in order to justify the higher dividend growth assumptions necessary to justify the current valuation of the US equity market, one has to assume that, for some reason, return on equity can remain sustainably so high.On Wall Street, it is indeed fashionable to point to the current high ROE as the explanation for the level of the stock market - this, after all, is what underlies the fashionable Economic Value Added approach to market valuation.For example, in arguing that the S&P500 was modestly undervalued (by about 8 per cent) comparing to the rest of the world, the Goldman Sachs US Strategy team, Einhorn et al. (1998), assumed that the spread between a company's return on capital (ROC hereafter) and its weighted average cost of capital (WACC hereafter) would be equal to its 1998 level (approximately 4.4 per cent) in perpetuity! This assumption is especially remarkable given that the ROC-WACC spread is, on their own numbers, currently at a record high (for the admittedly short sample of 1986-03). Note that the average value of the ROC-WACC spread over the 1986-03 period is about 1.6 per cent. It is striking that one has to assume that the ROC-WACC spread has to average more than 2 1/2 times its 1986-98 historical average in perpetuity in order to justify current equity market valuations in the US.However, the presumption that the ROC-WACC spread (or the ROE) can be sustainably high in the US is at variance with both theory and history. Standard considerations of product market competition suggest that any super-normal profits must ultimately be competed away. A strange aspect of the 'new paradigm' view is that we are supposed to believe simultaneously that the competitive forces unleashed by globalisation induce higher productivity growth and greater wage flexibility explicitly, but, implicitly, that the increase in global competition does not prevent the increase in monopoly power that is necessary to preserve the current high ROE.Next, if we turn to the empirical evidence, we are, first, much impressed by the evidence reported in Siegel, which suggests that, for the US over the past two hundred years, real returns on equity have been remarkably stable over the long run.Of course, over this period, the US economy has seen significant change. During 1802-71, the US evolved from an agrarian to an industrialised economy, while the 1871-1925 period saw it emerge as the foremost industrial power. During the post-WWII 1946-97 period, it has now evolved into a post-industrial, service- and technology-oriented economy. All this while, long-period averages of real returns on equities remained in a fairly narrow range, although with significant short-run variation; compare the negative real return over the 1966-81 period, with the above-average 12.8 per cent gain over the 1982-97 period2. Is it generally worthwhile for a...

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