The Role of Intangible Assets in Explaining the Investment Profit Puzzle

Starting around the early 2000s, and especially after the 2008 crisis, the rate of capital accumulation for U.S. nonfinancial corporations slowed, despite relatively high profitability, indicating a weakening link between profitability and investment. The literature mostly focuses on financialization and globalization as explanations.  This paper by Özgür Orhangazi proposes an additional influence—the increased use by nonfinancial corporations of intangible assets, such as brand names, trademarks, patents, and copyrights, especially in information technology, telecommuncations, and healthcare.  Orhangazi shows that firms in these sectors have higher mark-ups and profitability, but lower investment-to-profit ratios, contributing to the overall investment decline.

>> View this paper in the Cambridge Journal of Economics

Abstract

Starting around the early 2000s, and especially after the 2008 crisis, the rate of capital accumulation for US nonfinancial corporations has slowed down despite relatively high profitability; indicating a weakening of the link between profitability and investment. While the literature mostly focuses on financialization and globalization as the reasons behind this slowdown, I suggest adding another layer to these explanations and argue that, in conjunction with financialization and globalization, we need to pay attention to the increased use of intangible assets by nonfinancial corporations in the last two decades. Intangibles such as brand names, trademarks, patents, and copyrights play a role in the widening of the profit-investment gap as the use of these assets enables firms to increase market power and profitability without necessarily generating a corresponding increase in fixed capital investment. After discussing the ways nonfinancial corporations use intangible assets, I look at large corporations in the US and find that: i-) The ratio of intangible assets to the capital stock increased in general. This increase is highest for firms in high-technology, healthcare, nondurables and telecommunications. ii-) Industries with higher intangible asset ratios have lower investment to profit ratios. iii-) Industries with higher intangible asset ratios have higher markups and profitability. iv-) The composition of the nonfinancial corporate sector has changed and the weight of high-technology and healthcare firms has increased; but this increase did not correspond to an equal increase in their investment share. The decline in the investment share of durables, nondurables and machinery is matched by an increase in the investment share of location-specific industries with low intangible asset use, most notably firms in energy extraction. In general, these firms have steadier markups and higher investment to profit ratios. v-) Yet, intangible-intensive industries’ profitability has increased faster than their share of investment or total assets. All in all, these findings are in line with the suggestion that the increased use of intangible assets enables firms to have high profitability without a corresponding increase in investment.

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