The Big Company Advantage

The Big Company Advantage

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Even as the U.S. economy sputters, big companies are reporting massive profits. Analysts estimate third quarter earnings for S&P 500 companies jumped 27 percent from last year. That would bring earnings to a level on par with the third quarter of 2007, a year before credit turned into a crisis.  But the unemployment rate was 9.6 percent in September 2010, down only slightly from 9.8 percent a year ago and nowhere near the 4.7 percent rate of September 2007.
One explanation for this disparity is that labor productivity has increased; businesses are getting more from fewer employees.  Higher productivity means earnings could jump on modest sales growth.  Even so, the anemic U.S. economy could not have provided sufficient sales to cause the jump in earnings.

Foreign economies can provide the extra sales boost – for big companies. Foreign markets accounted for around half of revenue from S&P 500 companies. Coca-Cola generates around 75 percent of its sales abroad.   North American sales volume climbed just 2 percent, while international volume increased 6 percent. 

Big corporations have another advantage over small businesses: cheap and available credit.  If Starbucks wanted to borrow money to open new stores, it can hire a Wall Street investment bank to issue multi- million dollar bonds in the highly liquid corporate bond market.  Starbucks can easily scour the globe for the lowest possible interest rate, and get it.

Small business doesn’t have it so good. Joe the coffee shop owner isn’t big enough to approach Wall Street and tap the bond markets.  If Joe needs financing to open a second store, he has to go to his local bank and apply for a loan.  However, these banks are much more reluctant to expose their balance sheets to Joe’s risk.  Assuming they would grant the loan, the interest rate would be high. But banks aren’t even doing that.

Ultimately, the commercial space Joe had in mind for his little coffee shop becomes a Starbucks.

A few years ago, Joe’s bank would have gladly lent him money because it could easily sell that loan to a larger bank. That larger bank could then package Joe’s loan with hundreds of other loans through a process called securitization.  That package was called an asset-backed security (ABS).  The bank could then sell off slices of these ABSs as easily as Starbucks could sell bonds.

In the wake of the credit crisis, securitization has come under scrutiny because it encouraged small banks to lend recklessly.  Because of increased skepticism from investors and tighter restrictions from financial regulation reform, the securitization markets have all but dried up.  This has kept banks from lending to small businesses.

It is widely accepted that small businesses create more jobs than large companies in an economic recovery.  As conditions continue to favor big businesses, it is increasingly likely that elevated unemployment rates will persist.

The S&P 500 is often considered a proxy for the U.S. economy.  This is clearly a fallacy.

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