U.S. industry is being handicapped by the high cost of capital, according to a study sponsored jointly by the business lobbying group, American Business Conference, and Thermo Electron Corporation.
Since 1973, it has become much more expensive for industry to raise capital for investment, the study says. The high cost of capital is a major factor reducing the competitiveness of the United States relative to Japan, author George N. Hatsopoulos writes.
At a press conference, ABC Chairman Arthur Levitt used the study to argue for tax cuts to encourage industrial investment. This was a major theme of the 1981 Economic Recovery Tax Act, which has been described as providing huge tax cuts for companies. Hatsopoulos said that "our studies reveal that the overall impact of this legislation, although clearly beneficial, is much smaller than generally believed."
The cost of capital is tied both to the cost of equity and the cost of borrowing, Hatsopoulos says. It is generally much more expensive to raise equity than to borrow, he calculates. The after-tax cost of equity "increased abruptly and more rapidly than interest rates" in 1974, primarily because of the sharp decline in the stock market, the study says. Stock values fell "by an amount far greater than could be justified by changes in the return on capital and the dividend payout ratio."
In Japan, companies are typically much more dependent on debt for investment than in the United States. Since equity is more expensive than borrowing, this factor alone reduces the overall cost of capital to Japanese industry, Hatsopoulos says. "During periods of expansion, the leverage of a Japanese company can expand to levels many times higher than that in the U.S."