1. Introduction

The 2008 financial crisis, beginning in the USA and spreading globally, drew the financial systems of advanced economies to the forefront of public awareness, and led to a surge of research on the size and role of the financial sectors of advanced economies. Importantly, however, this surge of attention comes on the coattails of a secular expansion in finance – across countries and by a range of measures – since the 1970s. In the USA, for which the most detailed data are available, financial sector growth is evident as a share of GDP, employment, total profits or outstanding financial assets (Krippner, 2005; Greenwood and Scharfstein, 2013; Montecino et al., 2016). Similar trends occurred outside the USA as well: Philippon and Reshef (2013) document growth in the income share of finance across a set of developed economies (the UK, the Netherlands, the USA, Japan and Canada), and Jordà et al. (2016) measure an international expansion in private credit relative to income in the second half of the twentieth century.

This growth in the size and scope of modern finance is increasingly summarized as financialization. Broadly, financialization is perhaps most commonly defined as the ‘increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economies’ (Epstein, 2005, p. 3).¹ Importantly, this expansion of finance is reflected not only in the size and scope of the financial sector, but also in the behaviour of nonfinancial actors and in nonfinancial outcomes (see Krippner (2005) for an early elaboration of this point). Thus, while precise definitions vary across analyses, the shared premise underlying accounts of financialization is that this expansion of finance is a critical feature of the post-1980 USA economy, with substantive implications for foundational economic relationships (Palley, 2007; Sawyer, 2013; Fine and Saad-Filho, 2014; Epstein, 2015).

A substantial branch of the literature on financialization analyses, in particular, the relationship between financialization and fixed investment. Striking shifts in the balance sheet structure of nonfinancial corporations (NFCs) point to the financialization of traditionally nonfinancial firms, and suggest links between various aspects of financialization and investment. These trends are most fully documented for the USA (see Davis, 2016), where a shift in portfolio composition towards financial assets (Crotty, 2005) is, for instance, often used to suggest that financial investments increasingly replace – or ‘crowd out’ – fixed investment. Concurrently, firm balance sheets reflect changes in the structure of external finance, including growth in both indebtedness and own-stock repurchases, particularly among large firms (Davis, 2016). There is, correspondingly, an expansion in financial profits earned by nonfinancial firms (Krippner, 2005), and also in payments by NFCs to financial markets (Orhangazi, 2008a).

An increasingly complex relationship between NFCs and the financial sector is, also, evident in that some large NFCs, arguably, increasingly resemble financial firms (Froud et al., 2006), and also in a growing ‘portfolio conception’ of the firm, wherein NFCs are viewed as bundles of assets rather than capital-accumulating enterprises (Crotty, 2005). These changes in firm behaviour have come with a slowdown in capital accumulation, despite rising profitability, pointing to an ‘investment-profit puzzle’ in which a declining share of profits is reinvested in physical capital (Stockhammer, 2005; van Treeck, 2008, 2009a; Gutiérrez and Philippon, 2016). As is discussed below, this puzzle may reflect, for instance, growing shareholder orientation, wherein NFCs increasingly focus on financial indicators of performance over firm growth and fixed investment (Stockhammer, 2004; Davis, 2017).

Building on these stylized facts, a growing literature finds that features of financialization are systematically related to investment. However, there remains lack of consensus on the primary channels through which this relationship occurs, and even on the direction of the relationship. An influential first wave of empirical research suggests a decisively negative effect of financialization on investment (Stockhammer, 2004; Demir, 2007, 2009a,2009a; Orhangazi, 2008a,b; van Treeck, 2008); this relationship is, similarly, reflected in a body of theoretical literature (Stockhammer, 2004, 2005; van Treeck, 2008, 2009a; Dallery, 2009). Conversely, however, Boyer (2000) considers conditions for ‘finance-led’ growth, and Aglietta and Breton (2001) emphasize the role of asset price inflations in capital accumulation. Skott and Ryoo (2008), furthermore, highlight sensitivity to the theoretical specification of the investment function (Harrodian or Kaleckian). Davis (2017) points to varied relationships between different features of financialization and firm investment rates in the USA, including a positive correlation between financial assets and investment, but a negative effect of shareholder orientation. Kliman and Williams (2014) contend, in contrast, that falling accumulation rates in the USA are wholly unrelated to financialization.

This paper surveys this literature on financialization and investment to take stock of where we are and what remains to be done. To understand the range of conclusions reached in this literature it is, first, important to recognize that the definition of financialization remains nebulous and often varies substantially across papers. This variance in definition has both advantages and disadvantages. On the one hand, financialization summarizes a broad, wide-reaching process of structural change, and there is no a priori reason to expect all aspects of this phenomenon affect investment analogously. A range of empirical indicators, thus, has the advantage of capturing different aspects of financialization. On the other hand, the term ‘financialization’ is often applied differentially across analyses despite an often-implicit pretense that the same phenomenon is analysed. As such, it is increasingly unclear what is meant when one concludes that ‘financialization’ does or does not depress investment.² More specifically, within countries different empirical measures are used to draw different conclusions about financialization and investment, without clear reference to distinctions between the indicators used. Across countries, conclusions from one country – for example, regarding shareholder ideology in the USA – are sometimes also applied to other countries despite vastly different institutional settings. One contribution of this survey is, thus, a delineation of distinctions between studies that claim to otherwise study the same thing: ‘financialization’ and investment.

To understand the conclusions reached in this literature it is instructive to divide the literature into two parts. The first emphasizes financial flow-based indicators of financialization and changes in the relative stocks of fixed and financial assets, debt and equity on firm balance sheets. In the USA, for example, Orhangazi (2008a) finds that both increased financial payments made by NFCs and increased financial profits earned by NFCs are negatively associated with fixed investment, particularly among large firms. This analysis captures systematic negative relationships between fixed investment and growing income flows between NFCs and the financial sector. Notably, these results have been widely interpreted to imply that financial asset acquisitions ‘crowd out’ physical investment. In presenting this part of the literature, I emphasize, in particular, this possibility of crowding out. Importantly, more recent analyses do not find conclusive evidence of crowding out (Kliman and Williams, 2014; Davis, 2017) and, more generally, the literature emphasizing financial flows is characterized by variability in conclusions. This variability reflects, in part, differences in sample definitions and/or scope of analysis, but also points to a more general limitation of this branch of the literature.

In particular, while these financial flow-based indicators of financialization capture important changes in where profits accrue in the post-1980 USA economy they also raise further questions. These flows stem from firm decisions to acquire financial assets, or to borrow, repurchase stock or pay dividends. Thus, this expansion of financial flows, as well as changes in the structure of firm balance sheets from which these flows derive, raises the question of what has changed in NFC decision making – for example, in managerial objectives – such that a break in firm behaviour occurs specifically in the post-1980 period. Put differently, why has firm financial behaviour changed after 1980 such that investment rates have slowed? These determinants have important implications for understanding the relationship between financialization and investment. For example, the implication of higher leverage (with, correspondingly, higher interest payments) for fixed investment differs if firms borrow to exploit profitable fixed investment opportunities, to repurchase shares or to fund banking divisions (Davis, 2017). As the literature on financialization and investment expands, significant scope remains for identifying specific behavioural mechanisms underlying the stylized facts that summarize financialization, and for delineating differences in these behavioural stories across countries.

The second branch of the literature analyses shareholder orientation, which is the most fully developed behavioural explanation linking financialization to investment to date. Since the 1980s, the ‘maximization of shareholder value’ has become an increasingly dominant corporate governance ideology, particularly among USA firms (Lazonick and O'Sullivan, 2000; Fligstein, 1990; Davis, 2009). Shareholder ideology is, in particular, linked to changes in corporate strategy from one aiming to ‘retain and reinvest’ to one aiming to ‘downsize and distribute’ (Lazonick and O'Sullivan, 2000). Arising from agency theory, shareholder value ideology contends that closer alignment of managerial interests with those of shareholders – for instance, via stock-based managerial compensation – improves corporate performance (Jensen, 1986; Jensen and Murphy, 1990). The literature on financialization and investment, however, establishes evidence that shareholder orientation has adverse implications for firm investment, emphasizing both increased managerial attention to financial performance indicators like earnings per share (Stockhammer, 2004; Davis, 2017) and corporate myopia (Stout, 2012).

This paper, accordingly, surveys the literature on financialization and investment by introducing these two branches of the literature. The paper is organized as follows: Section 2 introduces definitions of financialization in the literature on financialization and investment. Sections 3 and 4 introduce the two main strands of the literature: increased flows between NFCs and finance, and shareholder orientation. Section 3, also, suggests limitations of analysing financialization and investment exclusively on the basis of financial flows and points to the importance of a behavioural understanding of financialization and investment. Section 5 concludes and suggests avenues for future research. Finally, a point about scope. The empirical literature on financialization and investment has, to date, focused disproportionately on the USA, reflecting in part the size and international dominance of USA finance and also that key mechanisms, like those related to shareholder orientation, are closely linked to country-specific institutions defining the degree of shareholder power. This survey follows this emphasis in the existing literature, but also introduces the literature exploring the relationship between financialization and investment in developing countries, which has focused largely on financial flows (Section 3).

2. Defining Financialization

All analyses of financialization that emphasize NFCs and investment underscore either an increasingly complex relationship between NFCs and financial markets, or stronger NFC orientation to financial performance targets. Orhangazi (2008a), for example, uses the concept quite broadly to ‘designate the changes that have taken place in the relationship between the nonfinancial corporate sector and financial markets’ (p. 3). Somewhat more narrowly, Lazonick (2013) emphasizes the financialization of corporate resource allocation, wherein companies are increasingly evaluated by measures like earnings per share, rather than by the goods and services produced.

However, specific definitions, and their empirical operationalizations, differ substantially. This variance in definitions – and also, more generally, the fact that financialization is an ambiguously defined term – has been widely noted (for example, Stockhammer, 2004, p. 721; Orhangazi, 2008a, p. 863; Skott and Ryoo, 2008, p. 827; Fine, 2013; Fiebiger, 2016). Nonetheless, there is little attention on the extent to which these conceptualizations of financialization do/do not overlap, or the degree to which different definitions explain different results in the literature. Accordingly, an important starting point for surveying the literature on financialization and investment is recognition and discussion of the definitions of financialization across the existing literature.

To highlight the main approaches to financialization in the literature on investment, Table 1 summarizes empirical definitions of financialization across this literature, focusing on empirical papers that analyse the financialization of the nonfinancial corporate sector and/or investment. In addition to econometric analyses of investment, Table 1 includes papers that do not explicitly investigate investment behaviour, but establish empirical evidence of financialization linked to the nonfinancial corporate sector (for example, Krippner (2005), which measures the financial incomes of nonfinancial firms). The summary in Table 1 calls attention to a heterogeneous set of changes in firm financial behaviour, including increased shareholder payouts and/or dividend payments, the rate of return gap between fixed and financial assets, and financially derived incomes. This range of definitions captures, on the one hand, that – as financialization reflects a broad process of structural change – it is inherently multi-dimensional. Different analyses should, therefore, emphasize different features of this broad process and, similarly, different features of financialization may affect investment behaviour differently. However, ambiguity in the definition of financialization also obfuscates distinctions underlying analyses of financialization and investment. In particular, varied empirical operationalizations of financialization imply that, as the literature on financialization and investment grows, it is increasingly unclear what is meant when one concludes that ‘financialization’ does/does not depress physical investment.

In addition to this heterogeneity, however, Table 1 also identifies three main approaches to measuring ‘financialization’. These approaches correspond to the main outline of this survey: the first two feature increased financial flows between NFCs and finance (Section 3), and the third emphasizes shareholder orientation (Section 4). In particular, one set of analyses emphasizes growth in the financial incomes of traditionally non-financial firms (Stockhammer, 2004; Krippner, 2005; Demir, 2007, 2009b; Orhangazi 2008a,b; Davis, 2017). Growth in holdings of financial assets (i.e. the stock of assets from which these financial profits derive) is, also, included in this category (see also Dögüs, 2016). A second set of papers highlights increased payments made to finance by nonfinancial businesses, including interest, dividends and/or stock repurchases (Orhangazi 2008a; van Treeck, 2008; Onaran et al., 2011; de Souza and Epstein, 2014; Kliman and Williams, 2014). Finally, a third set of studies aims to operationalize shareholder value orientation (Stockhammer, 2004; van Treeck, 2008; Orhangazi, 2008a; Mason, 2015; Davis, 2017); in some cases, these papers, also, equate financialization with shareholder value ideology. Note that Table 1 lists papers fitting into more than one of these three categories multiple times: for instance, Orhangazi (2008a) emphasizes aspects of financialization linked both to financial incomes and payments to finance.

At least two additional points fall out of this categorization. First, even within each subset of the literature there are meaningful differences in measures of financialization. For example, higher financial payments have been captured empirically by payments to creditors and shareholders (Orhangazi, 2008a); by dividend payments to shareholders (van Treeck, 2008); and by all shareholder payouts, including both dividends and repurchases (Mason, 2015). In the post-1980 USA these measures are qualitatively different: shareholder orientation is associated with a growing prioritization of shareholder payouts, and own-stock repurchases are consistent with the increasing prioritization of capital gains over long-term dividend growth (see Section 4). Second, the delineation between empirical indicators employed and the mechanisms that are emphasized is sometimes unclear. For instance, Stockhammer (2004), Demir (2007, 2009b) and Orhangazi (2008a,b) exploit, at least in part, similar indicators (an increase in financial profits/rentiers’ income). Across these papers, however, the interpretation of the relationship between this measure of financialization and investment differs in important ways: Demir suggests financial profits crowd out fixed investment; Stockhammer uses the indicator to explain changes in firm behaviour associated with shareholder value; and Orhangazi's interpretation incorporates elements of both.

In addition to the categories outlined in Table 1, two additional branches of the literature on financialization and NFCs can be identified. One emphasizes links between the international reorganization of production, global value chains and the financialization of USA firms (Milberg, 2008; Milberg and Winkler, 2010, 2013). Milberg (2008), for example, analyses an ‘offshoring-financialization’ linkage, wherein offshoring fails to generate dynamic gains in investment by USA firms because these firms increasingly purchase financial assets and repurchase stock, rather than (domestically) reinvesting higher profits. Fiebiger (2016), also, links financialization and ‘de-nationalization’ in production, pointing to a range of measurement issues arising in the context of expanded USA production abroad after the mid-1990s. Outside of these contributions, however, this branch of the literature remains relatively sparse, in part due to data limitations and, in particular, explicit links to investment remain to be drawn.

A final theme emphasizes volatility and uncertainty, most often in the context of financial liberalization in developing and/or emerging market economies (Demir, 2009a,2009c; Akkemik and Özen, 2014; Seo et al., 2016). Building on evidence that financial liberalization both increases macroeconomic uncertainty and increases firms’ opportunities to invest in financial assets, uncertainty and/or risk become key parameters mediating firms’ portfolio allocation decisions between illiquid capital investments and liquid financial investments (Demir, 2009b). Rising firm-level volatility also characterizes the USA experience over this period (Comin and Philippon, 2005); linking volatility and growth in firm financial asset holdings in the post-1970 USA, Davis (2017) introduces firm volatility into the investment function and captures a negative link between volatility and investment. The role of uncertainty and risk in mediating the relationship between financialization and investment remains, however, relatively underexplored. Existing evidence raises further questions about how firms’ portfolio decisions may be differentially impacted by idiosyncratic risk and macro-level uncertainty, as well as about differences in the responsiveness of portfolio allocation decisions to risk in developed and developing economies.

3. Firm Financial Behaviour and Investment

The first branch of the literature on financialization and investment analyses the consequences of secular shifts in the balance sheet structure of NFCs, and the financial flows derived from these balance sheet stocks, for fixed investment. This literature draws primarily on Keynesian and Minskian approaches, which emphasize the importance of financial factors in investment (Eichner and Kregel, 1975; Minsky, 1975; Skott, 1989; Crotty, 1990, 1992; Lavoie, 2014). The role of financial factors in investment is, however, also widely accepted outside of the post-Keynesian literature (see, for example, Fazzari et al., 1988).

This section follows the first two panels of Table 1 to introduce the main results in this segment of the existing literature. In each case, I first introduce the trends in the asset and liability sides of firms’ balance sheets, respectively, that motivate analyses of financialization and investment. This literature highlights systematic relationships between changes in firm financial behaviour and investment, but also raises questions for further analysis, not least because the existing empirical literature points to sometimes-contradictory conclusions. In some cases, different results undoubtedly stem at least in part from different sample definitions and empirical methods; instances of these differences are pointed to in the discussion below. In other cases, different conclusions reflect different empirical approaches to defining financialization. Finally, and most importantly from a conceptual perspective, these differences motivate a behavioural approach to financialization and investment in future research that, in particular, emphasizes determinants underlying changes in firm financial behaviour.

3.1 Financial Profitability and Financial Asset Holdings

3.1.1 Post-1970 Trends in Portfolio Composition and Profitability

A first striking feature of the post-1970 period in the USA economy is secular growth in the financial asset holdings of the nonfinancial corporate sector. This portfolio shift is highlighted in Figure 1, which plots financial assets and fixed capital, each relative to sales between 1950 and 2014, in the median across USA NFCs. While both series are largely stable through the 1950s and 1960s, they diverge in the early 1980s; the ratio of financial assets to sales, in particular, climbs from approximately 25% in 1980 to 47.4% of sales in 2014. The firm-level decomposition in Davis (2016) indicates that this portfolio shift holds across firm size and industry, as well as when financial assets are normalized by other measures of firm size.

Together with this expansion in financial asset holdings comes growth in NFC incomes from financial sources. Krippner (2005, 2011) documents growth in portfolio income (interest, dividends and realized capital gains) relative to corporate cash flow earned by the nonfinancial corporate sector beginning in the 1970s and accelerating during the 1980s; this ratio signals a growing ‘extent to which non-financial firms derive revenues from financial investments as opposed to productive activities’ (2005, p. 182). Orhangazi (2008a,b), similarly, highlights growth in NFCs’ financial incomes, documenting an increase in two specific sources of financial income – interest and dividend income – relative to internal funds after the early 1970s. Dumenil and Levy (2004a) document growth in French nonfinancial firms’ holdings of other firms’ stock, as well as corresponding growth in dividend income, thereby also accentuating ‘strong increases in financial revenues in relation to revenues linked to the main activity of firms’ (p. 118). Furthermore, while rentiers’ income most commonly refers to economy-wide private-sector financial profits (clearly a broader concept than the financial profits of nonfinancial firms), growth in rentiers’ income corroborates these trends, and also extends the evidence to a set of Organization of Economic Cooperation and Development (OECD) economies (Epstein and Power, 2003; Epstein and Jayadev, 2005; Dünhaupt, 2012). Rising financial incomes are also identified as a key manifestation of financialization in developing and emerging market economies, where financial liberalization has been followed by pressure to maintain high interest rates to sustain capital inflows (Demir, 2009a,2009b; Bonizzi, 2013).

These financial cash flows should, furthermore, be distinguished from financial profit rates. As such, growth in financial asset holdings and financial incomes, also, raises the question of the rate of return earned on financial assets. Dumenil and Levy (2004b) find that financial incomes – net interest, dividends, holding gains on assets and profits due to the devaluation of liabilities by inflation – increase overall profit rates in the USA between the early 1950s and 1982. After 1982, however, the gap between measures of the profit rate that do/do not incorporate financial factors largely disappears. Accordingly, financial relations most significantly improve USA firms’ profitability at the beginning of firms’ portfolio reallocation towards financial assets. This point is corroborated by the firm-level financial profit rates in Davis (2016), defined as firm-level interest and dividend earnings relative to financial assets (p. 135). This financial profit rate is positive for the full post-1970 period, but does not trend upwards with the exception of a small increase in large firms’ financial profitability in the early 2000s (a period Dumenil and Levy's data does not include). Notably, the absence of a significant trend in financial profit rates is consistent with the fact that a large share of financial asset growth among USA firms is in highly liquid assets, yielding interest but not necessarily high returns (Davis, 2016).

It is, finally, important to note data limitations involved in measuring the total financial profits of nonfinancial firms. Total financial profits of NFCs include total interest income, dividend income (both from subsidiaries and affiliates, and other dividends) and capital gains (Krippner, 2005). Capital gains, in particular, include cash flows from net foreign exchange gains/losses, gains/losses from marketable securities and other short-term investments and gains/losses from sales of shares in other companies (Demir, 2009b). However, reporting requirements make it difficult to uniquely identify each of these income streams, such that total financial profits are difficult to document.

Thus, while Orhangazi (2008a), for example, documents a clear upward trend in two well-defined categories of financial income (interest and dividend income) at the sector level, this trend underestimates total financial profits both because it excludes other sources of financial income like capital gains (see Orhangazi, 2008a, p. 877), and because the Flow of Funds nets out within-USA within-sector holdings, such that dividends earned from stock of other USA NFCs are not included in dividends received (see Dumenil and Levy, 2004b, p. 102). Measurement issues arise in the firm-level data for the USA as well, in which it is neither possible to obtain a measure of capital gains nor to clearly identify all sources of financially derived income (see again Orhangazi, 2008a, p. 877; Davis, 2017). Notably, to measure capital gains at the sector level, Krippner (2005, 2011) uses (non-publicly available) Internal Revenue Service (IRS) data.³ It is, accordingly, important to take note of differences in the definitions of financial profits across analyses.

3.1.2 Do Financial Assets ‘Crowd Out’ Capital Investment?

An influential set of empirical papers emphasize this expansion in financial assets and incomes, and consider whether the portfolio shift towards financial assets has come at the expense of physical investment. This channel has come to be known as the ‘crowding out’ thesis (for this usage see, as examples, Teixeira and Rotta, 2012, p. 454; van der Zwan, 2014, p. 14). This possibility is first analysed by Demir (2007, 2009a) and Orhangazi (2008a,b) who hypothesize that an increase in financial profits generates a portfolio reallocation towards financial investments that, in turn, reduces investment rates. Following Tobin (1965), if the yields of two categories of assets differ, these assets are held in proportions depending on their relative yields (p. 768); imperfections in financial markets and risk-diversification strategies ensure that nonzero quantities of both assets are held. Therefore, when internal funds are limited, there is ‘substitutability of real and financial assets in portfolio balances’ (Demir, 2009a, p. 314), such that ‘increased financial investments could have a negative effect [on real investment] by crowding out real investment’ (Orhangazi, 2008a, p. 865).⁴

This hypothesis is consistent with a growing ‘portfolio view of investment’ (Demir, 2009b, p. 316), wherein nonfinancial firms with increased access to financial markets exploit the availability of relatively quick and high financial returns. All else equal, an increase in the rate of return on financial assets effectively increases the ‘hurdle’ rate NFCs must expect to earn on fixed capital in order to allocate funds towards fixed assets, thereby reducing fixed investment rates as firms allocate (limited) funds towards financial investments (Demir, 2009b). While Demir emphasizes emerging markets, Crotty (2005), similarly, argues in the USA case that a key dimension of financialization is a ‘shift in the beliefs and behavior of financial agents…. to a “financial” conception [of the nonfinancial firm] in which the NFC is seen as a “portfolio” of liquid subunits’ (p. 88; see, similarly, Fligstein, 1990). Uncertainty, furthermore, implies firms may prefer investment in liquid, reversible financial assets over irreversible fixed capital when financial assets offer higher or even comparable rates of return (Crotty, 1990; Tornell, 1990; Demir, 2009a). This point is important: an excess of financial over real rates of return is not necessary for financial profitability to reduce investment rates; instead, a decline in the gap between real and financial profitability or an increase in uncertainty may be sufficient to depress investment.

This hypothesis is most often tested empirically by introducing financial cash flows or financial profit rates into estimations of the investment function.⁵ The inclusion of financial profits into investment specifications is common across the literature on financialization and investment, whether directly via total financial earnings (Stockhammer, 2004; Orhangazi, 2008a,b; Demir, 2009c; Onaran et al., 2011; Seo et al., 2016; Tori and Onaran, 2017), the differential between rates of return on real and financial assets (Demir, 2007, 2009b) or the financial profit rate (Davis, 2017). Note that while Stockhammer's (2004) theoretical model concerns shareholder orientation (discussed in Section 4), the main empirical proxy for financialization – the interest and dividend income of the nonfinancial business sector – is closely tied to this section of the literature.

The empirical results in each of these papers point to a negative relationship between financial income and investment rates in some specifications or subsamples. This relationship is, perhaps, the strongest in Demir's (2009b) estimates for Argentina, Mexico and Turkey, which test whether an increase in the gap between real and financial profit rates decreases fixed investment. Demir finds a positive and statistically significant effect of this gap on investment, robust across specifications (p. 320). Orhangazi (2008a), similarly, finds a strongly statistically significant negative relationship between financial profits (normalized by the capital stock) and investment, although only among large firms. In fact, the relationship between financial incomes of the full sample of USA NFCs and investment is positive, albeit statistically insignificant. At the aggregate level, Stockhammer (2004) finds statistically significant evidence of a negative relationship between financial profits and capital investment in the USA and, in some specifications, also in the UK, but little evidence of a negative relationship in France or Germany. Notably, the statistical significance of this relationship disappears for the USA as well when also controlling for financial payments (Stockhammer, 2004, p. 735); these estimations that include both financial incomes and payments align with the statistically insignificant full-sample result in Orhangazi (2008a) and also the aggregate estimations in Orhangazi (2008b).⁶

Thus, while these papers point to a negative relationship between NFCs’ financial incomes and investment in some specifications, the results are sufficiently mixed to suggest that evidence of ‘crowding out’ is not clearly robust across contexts and specifications. As such, this literature raises questions about the necessary conditions for ‘crowding out’ to hold. Perhaps most importantly, the theoretical robustness of the predicted negative relationship hinges on the assumption that internal funds are limited. This assumption of limited internal funds excludes, however, two relevant cases: first, a case in which financial earnings augment a firm's available funds such that (some proportion of) these total funds may be allocated towards physical investment and, second, a case in which firms borrow to augment internal funds.

The first possibility is that financial earnings augment firms’ pools of internal funds, which can then be allocated in some proportion towards fixed or financial assets. Importantly, there is no a priori reason to expect these funds will be allocated entirely towards financial acquisitions, much less cause a further reduction in the acquisition of fixed assets. Demir (2009c), for example, finds that cash flows from financial investments have a positive effect on fixed investment in Turkey, although this positive effect is substantially smaller in magnitude than the (positive) effect of cash flow from operating profits. This result suggests that, in some circumstances, financial profits act as a dynamic ‘hedging mechanism’ that offer NFCs additional cash flow in subsequent periods, particularly in times of high uncertainty (p. 959). In other words, cash flows from financial investments may have a long-run positive effect on fixed capital investment. Notably, this analysis emphasizes financial cash flows; in contrast, Demir's (2009b) findings emphasize financial rates of return (i.e. financial profits per unit of financial assets), wherein a relative improvement in financial profitability relative to real profitability leads to a portfolio reallocation towards financial assets that depresses fixed investment.

In some contexts, however, financial profit rates may also complement ‘real’ earnings. Davis (2017), for example, presents evidence consistent with the negative predicted relationship between financial profit rates and investment above across all USA NFCs; however, firm size sub-samples point to a positive short-run relationship between financial profitability and investment for the largest quartile of firms.⁷ This result suggests possible complementarities between financial profits and the nonfinancial aspects of firms’ businesses that are only captured by the largest firms in the USA economy (Davis, 2017, p. 18). For instance, this result may corroborate examples of (large) NFCs’ expansion into the provision of financial services, including NFC provision of car loans and store-issued credit cards (Froud et al., 2006). These cases of captive finance not only generate financial profits, but also capture demand for a firm's nonfinancial output, thereby supporting fixed investment. This discussion, furthermore, suggests that – for firms able to capture these types of complementarities – a large differential between returns to lending and borrowing may not be necessary to generate NFC movement into financing activities.

Second, access to external finance (new borrowing) that augments a firm's pool of internal funds also implies that the acquisition of financial assets need not come at a trade-off with fixed investment.⁸ Because firms make investment and financing decisions subject to a finance constraint, decisions regarding uses of funds are interdependent with decisions regarding external finance. Notably, in the USA context, the post-1980 expansion of financial incomes and financial investments is concurrent with an expansion in gross debt on NFC balance sheets (see Section 3.2), suggesting that – at least at the sector-level – firms are not constrained in new borrowing. In this context, ‘crowding out’ – or what Kliman and Williams (2014) term ‘diversion’ of the share of profits invested in production towards financial uses – need not have taken place.

Kliman and Williams (2014), instead, contend that USA NFCs’ financial asset acquisitions were ‘almost wholly funded by means of newly borrowed funds throughout the entire post-World War II period’ (p. 77). While this conclusion is based on aggregate data showing the relative magnitudes of changes in financial asset holdings and liabilities, such that it is not possible to disambiguate what funds are used for what (only that, at the sector level, there are ‘enough’ funds to cover new financial assets out of new borrowing), this conclusion is also supported by the firm-level estimations in Davis (2017). Investment specifications that include NFCs’ outstanding stock of financial assets, in addition to the flows of income earned off these assets, point to a positive and strongly robust relationship between firm-level financial asset holdings and fixed investment (in the short-term, over time and across firm-size specifications). Thus, holding expected returns constant, ‘firms acquire financial assets – which ameliorate inherent risks of long-term and irreversible capital investments – concurrently with fixed capital’ (p. 20), similarly, suggesting that financial assets have not directly crowded out fixed capital investment among USA firms. Seo et al. (2016), similarly, find no evidence of a crowding out relationship between financial asset acquisitions and fixed investment in Korea.

Among firms facing constraints in access to external finance, however, the acquisition of financial assets may come at a trade-off with fixed capital investment. Thus, the fact that Demir (2009b) finds robust evidence of crowding out in emerging market economies is consistent with the expectation that credit rationing constrains a more significant set of firms in an emerging market context. Demir, furthermore, draws on these results to point to the persistence of capital market imperfections in Argentina, Mexico and Turkey, arguing that – despite predictions that financial liberalization should deepen capital markets and reduce agency costs, in turn, increasing capital market efficiency – there is no robust evidence of a reduction in credit rationing for these real-sector firms. In addition to highlighting the role of credit constraints, this discussion speaks to a broader point: namely, that the key mechanisms through which financialization is linked to changing investment behaviour are likely to vary across countries, in line with historical and institutional differences (see Lapavitsas and Powell, 2013; Seo et al., 2016; Karwowski and Stockhammer, 2017), as well as – within countries – both over time and by ‘types’ of firm (for example, those that are credit constrained versus those that are not).

3.2 Debt and Investment

A dramatic rise in NFC (gross) leverage is, also, a key stylized feature of the post-1980 period in the USA economy that has been emphasized extensively in the financialization literature. This expansion of debt is evident both at the sector level (Palley, 2007), and also at the firm level among large corporations (Davis, 2016). Figure 2 plots the firm-level yearly means of total outstanding debt relative to total capital between 1950 and 2014 for the full USA nonfinancial corporate sector, capturing a dramatic expansion in debt over the post-1980 period. As indicated by the discussion in Section 3.1.2, new borrowing is closely linked to accounts of financialization and investment, particularly in the post-1980 USA economy. As a source of funds, new borrowing can be channelled towards three types of uses of funds: investment in fixed capital, investment in financial assets (or, analogously, saving) or ‘swapping’ debt for equity.

Importantly, the financialization literature suggests a ‘de-linking’ between borrowing and physical investment in the post-1980 USA economy. Kliman and Williams (2014) contend, for instance, that borrowed funds are an ‘increasingly large source of the funds that drive the financialization process’ (p. 76), where ‘financialization’ refers to dividend payments and financial asset acquisitions. Using firm-level data, Mason (2015) points to a declining correlation between new borrowing and physical investment after the early 1980s. Similarly, the USA nonfinancial corporate sector's dependence on external borrowing for investment falls after the early 1980s, such that a declining share of sector-level capital investment is financed with external funds (de Souza and Epstein, 2014). De Souza and Epstein (2014), also, document similar trends for five European countries with major financial centres (the UK, Germany, the Netherlands, Switzerland and France). Notably, in Germany, the UK and Switzerland, this trend is sufficiently dramatic that the nonfinancial corporate sectors become net lenders of funds to the rest of the economy, reversing traditional patterns of inter-sectoral lending.

Given this ‘de-linking’, the literature on financialization suggests at least two possible reasons why firms (increasingly) borrow, without channelling these borrowed funds into traditional investment. First, a large – and growing – subset of the financialization literature suggests that growth in debt and shareholder payouts in the USA economy are linked (Dumenil and Levy, 2011; Kliman and Williams, 2014; Mason, 2015; Fiebiger, 2016). Of particular importance is the possibility that ‘financing for stock repurchases has been mainly from borrowing rather than from profits’ (Fiebiger, 2016, p. 355), such that debt increasingly replaces equity on NFC balance sheets. However, complete consideration of this channel also requires a discussion of shareholder value orientation, and is postponed to Section 4.

It is, second, plausible that (at least some part of) the expansion in borrowing is used to fund financial asset acquisitions. As discussed above in the context of crowding out, if financial asset acquisitions draw from borrowed funds, they need not come at a trade-off with fixed investment. Importantly, this point raises the question of why firms may borrow simply in order to hold more financial assets. Perhaps most notably, borrowing to fund financial asset acquisitions is consistent with the possibility that large NFCs are increasingly engaged in the provision of financial services. The clearest evidence of this possibility comes from case studies of large firms – like General Electric, General Motors and Ford – that have expanded their scope into banking activities (Froud et al., 2006). In the case that nonfinancial firms increasingly act like financial firms, their balance sheets structures should also more closely resemble those of financial firms (and, accordingly, be characterized by larger gross holdings of both debt and financial assets). More generally, however, this example indicates the importance of tying changes in NFC financial structure to behavioural changes, so as to disentangle, for example, the possibility that financial investments ‘crowd out’ capital investments, from the possibility that firms borrow to fund financial investments.

4. Shareholder Value Orientation

The primary behavioural channel analysed extensively in the existing literature, which links firms’ financial outcomes to changes in firm behaviour, emphasizes a shift in corporate governance norms associated with the growing entrenchment of shareholder value ideology (Lazonick and O'Sullivan, 2000; Davis, 2009). Arising out of the application of agency theory to firms, shareholder value ideology contends that agency problems between shareholders (owners) and managers lead to inferior corporate performance. The agency problem is argued to derive from moral hazard: managers may apply ‘insufficient effort’, undertake ‘extravagant investments’, pursue ‘entrenchment strategies’ to make themselves indispensable, or exploit expensive perks like private jets or box tickets to ball games (Tirole, 2006, p. 17). To mitigate this moral hazard, agency theory suggests specific mechanisms to better-align managerial and shareholder interests including a hostile market for corporate control (Jensen, 1986, p. 324) and stock-based executive compensation (Jensen and Murphy, 1990). While these mechanisms are designed to improve firm performance, the literature on financialization has linked changes in firm behaviour associated with growing shareholder orientation – and, in particular, increased managerial attention to financial measures of firm performance defined on a short-term basis – to declining fixed investment rates.

4.1 The Entrenchment of Shareholder Orientation in the USA Economy

The development of institutions supporting the maximization of shareholder value is particularly dramatic in the USA economy. Because these changes depend significantly on country-specific institutions defining the degree of shareholder power, it is, therefore, useful to specifically introduce the USA case. In the USA, these changes are summarized by a shift from the Chandlerian managerial firm of the initial post-WWII period – in which professional managers ran corporations with little shareholder oversight (Chandler, 1977) – to a ‘financialized’ or ‘rentier-dominated’ firm following the shareholder revolution (Stockhammer, 2004; Crotty, 2005; Mason, 2015). This ‘financialized’ or ‘rentier-dominated’ firm is characterized by a shift in managerial priorities towards an emphasis on shareholder interests and, in particular, the interests of short-term shareholders (Stout, 2012).

A wide-reaching set of institutional and regulatory changes over the post-1980 period – including growth in institutional investors, an expansion in stock-based executive pay, and regulatory changes encouraging stock buybacks – have supported this shift in corporate governance norms, encouraging attention to shareholder payouts and the ‘maximization of shareholder value’. First, the post-1980 period is characterized by significant changes in the structure of stock ownership, wherein institutional and activist investors increasingly dominate shareholding. Growth in the share of USA equities managed by institutional investors rises from 33% of total stock market capitalization in 1980 to 67% of by 2010 (Blume and Keim, 2012). Institutional ownership is, also, importantly, characterized by a shorter duration of stock ownership. Accordingly, stock market turnover has risen substantially over this period. Figure 3 highlights this increase in stock market turnover in the USA between 1980 and 2014; in this figure, the stock market turnover ratio is defined as the total annual value of shares traded relative to average market capitalization. Together with the expansion in institutional investors, increased turnover reflects a marked departure from the pre-1980 period – dominated by long-term household-level stockholding – towards increasingly ‘impatient’ stock market finance (Crotty, 2005).

The expansion of institutional investors, together with changes in Securities and Exchange Commission (SEC) rules increasing the ease of communication between shareholders, has manifested in ‘shareholder activism, with large outsider investors publicly pushing management to increase payouts and adopt “value-enhancing” policies, pushing for seats on the board, sponsoring resolutions, and threatening to sell their shares en masse’ (Mason, 2015, p. 12). Crotty (2005) argues that this ‘impatient finance’ has contributed to growing emphasis on capital gains over long-term measures of firm performance and growth. Stout (2012), similarly, frames the expansion of institutional stock ownership in terms of the increasing power of short-term shareholders relative to long-term shareholders, generating ‘corporate myopia’ (p. 65). Short-term stockholding comes with a different set of incentives and, in particular, generates preferences for quick capital gains over long-term dividend growth. The rise of institutional and activist investors has, thus, arguably changed the constraints subject to which NFC managers operate, requiring greater managerial attention to stock-based indicators of performance.

Second, an expansion in stock-based executive pay directly affects managerial preferences by linking executives’ individual payoffs to the firm's stock performance (Lazonick and O'Sullivan, 2000). Frydman and Jenter (2010) document an upswing in stock option compensation in the early 1980s and emphasize, ‘The purpose of option compensation is to tie remuneration directly to share prices and thus give executives an incentive to increase shareholder value’ (p. 5; emphasis added; see also Lazonick, 2013). The expansion of stock-based executive pay has, notably, also been supported by tax code changes, including a 1993 amendment to the tax code (Code 152(m)) stipulating a $1 million cap on nonperformance-based pay, but no cap on ‘performance’-based pay. ‘Performance’ has, in turn, become increasingly synonymous with stock-price performance (Stout, 2012). Institutional investors have also been involved in the push for stock-based managerial pay (Lazonick 2009; Krippner, 2011). Hartzell and Starks (2003), for example, document that institutional ownership is tied to pay-for-performance sensitivity in executive compensation, where ‘performance’ again reflects stock price performance. A related change lies in a growing ‘market for managers’: whereas the initial post-WWII period was characterized largely by promotion within firms, an expanding ‘market for management’ has meant top management is increasingly likely to be brought in from outside the firm (Crotty, 2005; Kaplan and Minton, 2011; Mason, 2015).

These institutional changes are, third, supported by regulatory changes supporting own-stock repurchases. Of particular note is SEC Rule 10b-18, which first opened scope for (legal) large-scale repurchases by protecting managers from the threat of insider trading charges for targeting the firm's stock price (Grullon and Michaely, 2002; Lazonick, 2013; Davis, 2016). Further rule updates in 1991 and 2003 expand these safe harbour provisions, and shorten the waiting period between exercising and selling stock options (Lazonick, 2013; Davis, 2016). The dramatic post-1980 expansion in stock repurchases among USA corporations is closely correlated with these regulatory changes (Lazonick and O'Sullivan, 2000; Crotty, 2005; Davis, 2016). This secular expansion in repurchases is shown in Figure 4, which plots average industry-level repurchases across USA NFCs between 1970 and 2014; Figure 4 also indicates that this trend begins in 1983 (following SEC Rule 10b-18). Repurchase growth is accompanied by (more gradual) dividend growth; thus, total shareholder payouts exhibit secular growth after 1980, and dividends comprise a declining share of these total payouts over time (Grullon and Michaely, 2002). Importantly, own-stock repurchases clearly capture NFC emphasis on shareholder value. By repurchasing shares, managers increase stock-based performance measures (like return on equity, or earnings per share), for otherwise given profits. Thus, repurchases both appease institutional investors, and directly affect the part of executive pay comprised of stock-based instruments.

4.2 Shareholder Value and the Post-Keynesian Theory of the Firm

Growth in NFC own-stock repurchases, importantly, draws a clear link between shareholder orientation and changes in NFC financial behaviour associated with the financialization of nonfinancial firms (namely, increased shareholder payouts). In turn, shareholder value orientation has been linked to investment via changes in managerial objectives and/or the constraints subject to which managers make portfolio and financing decisions. The increasing entrenchment of shareholder value ideology has, first, been linked to firm investment behaviour via changing managerial objectives (Stockhammer, 2004; Davis, 2017). The rationale for analysing the impact of shareholder orientation on firm behaviour via changes in managerial objectives is perhaps most clearly reflected in the growing share of stock-based executive pay, which directly aligns managerial and shareholder interests. As such, managers are increasingly oriented towards short-term profitability – and, more specifically, stock-based performance indicators – such that managerial willingness to tie up funds in long-term irreversible fixed capital declines.

Building on the post-Keynesian theory of the firm in Lavoie (2014), Stockhammer (2004) develops a theoretical framework analysing the impact of changes in managerial preferences on investment, via a shift from ‘growth-maximizing’ to ‘profit-maximizing’ objectives. The investment decision, pictured in Figure 5, is determined by managerial objectives, the firms’ finance constraint (g^FC), and the firms’ output expansion function (r^RG) (Stockhammer, 2004; for additional elaborations of this framework see also Dallery, 2009; Hein and van Treeck, 2010; Lavoie, 2014). The finance constraint defines the maximum level of growth that can be financed by a given rate of profit. The output expansion frontier, in turn, defines the profit rate that can be achieved for a given investment rate (growth strategy). The firm is assumed to operate on the concave portion of the output-expansion function, such that additional investment harms profits – that is, there is a ‘growth-profit trade-off’.⁹

The theoretical specification emphasizes the separation between ownership and control to introduce the possibility of divergence between managerial and shareholder preferences. Prior to the entrenchment of shareholder ideology, managers maximize firm growth (the investment rate), despite shareholders’ preferences for profit maximization. As such, managerial preferences are defined by U¹_M in Figure 5 (where U¹_M = u(g)), whereas owners’ preferences (U_O) are a function of profits (r). As shareholder value orientation becomes increasingly entrenched, managerial preferences become increasingly ‘profit-maximizing’ (shown by the rotation to U²_M = u(g, r)). As Figure 5 indicates, this increasingly ‘profit-maximizing’ managerial orientation, accordingly, drives a decline in the firm's investment rate (from the investment rate of the ‘managerial firm’, g^MF, to the lower investment rate of the ‘shareholder-dominated firm’, g^SF).¹⁰

Changes in firm financial behaviour associated with shareholder value – including, most notably, increased financial payout ratios – may, furthermore, change the position of the firm's finance constraint (Hein and van Treeck, 2008; Hein and van Treeck, 2010). In particular, the finance frontier rotates so as to further constrain the investment rate available to firms. Hein and van Treeck, (2010) contend that shareholder value orientation is, accordingly, associated not only with a change in managerial objectives, but also with a change in the firm's constraints as shareholders ‘compel firms to distribute a larger portion of profits’ (p. 210). Note, however, that an increase in distributed profits can also be understood as endogenous to the change in managerial preferences: namely, shareholder payouts increase and affect the position of the finance constraint because of the change in managerial objectives. As such, any changes in the position of the finance frontier are, in fact, also a consequence of changing managerial objectives. Furthermore, if shareholder payouts are financed, at least in part, through increased borrowing, this expansion in borrowing (reflecting additional finance available to the firm) can offset the shift in the firms’ finance constraint. Finally, Fiebiger (2016) contends that a concurrent shift in production from the domestic to the international sphere mitigates the extent to which the utility function describing managerial preferences rotates in the context of shareholder orientation; in particular, international fixed investment may, to some extent, have replaced domestic fixed investment.

5. Conclusions

This paper has surveyed the strand of the financialization literature that emphasizes fixed investment and capital accumulation. In this literature, there is growing consensus that certain features of financialization – in the USA context, most notably shareholder orientation and corporate short-termism – depress physical investment. Given the key role of fixed investment in economic growth, this literature raises important questions about the long-term macroeconomic effects of increased attention to short-term financial market-based indicators of firm performance in the USA economy. Notably, the possibility of economically meaningful negative links between financialization and capital accumulation is also echoed in a more recent mainstream literature that finds that, beyond a certain threshold, financial sector growth negatively effects GDP growth (Cecchetti and Kharoubi, 2012; Law and Singh, 2014; Arcand et al., 2015). Together, these results increasingly call into question a long-held tenet in mainstream macroeconomics: that more finance leads to more growth (Levine, 1997). Thus, as a largely heterodox literature on financialization has raised the question of ‘how big is too big?’ with respect to the size of the financial system (Epstein and Crotty, 2013), in the mainstream literature as well there is ‘an emerging notion: that there can be “too much finance”’ (Jordà et al., 2016, p. 32).

This survey also indicates directions for future research. As discussed above, for example, the key role of risk and uncertainty in mediating firms’ demand for liquid versus illiquid assets suggests that linkages between financialization, risk, uncertainty and investment behaviour should be further analysed in future research. The existing literature, furthermore, focuses on corporations – both due to data availability (given corporations’ public reporting requirements) and because key themes in the literature on financialization (like shareholder orientation) are closely tied to the stock market. However, selection into the corporate form is nonrandom (Demir, 2009a); additionally, the role of the corporate sector in total business investment varies over time and place. Systematic differences in the characteristics of listed and nonlisted firms – for instance, in access to debt and equity finance – raise the possibility of distinct relationships between financialization and the investment behaviour of public and private firms. More broadly, considerable scope remains to isolate key characteristics of the relationship between financialization and investment for different types of firms: public and private, foreign and domestic, those in developed and developing economies. Finally, while most research to date has utilized annual data, higher-frequency data have the potential to offer new insight into determinants of firm portfolio choice. While annual data are well-suited to describing longer-term trends, the end-of-year values on annual income and balance sheet statements cannot capture short-term portfolio adjustments (specifically of liquid financial assets) throughout the year (see Demir (2009b) for an analysis that, instead, uses semi-annual data).

These directions for future research can all contribute to further development of a behavioural narrative explaining links between post-1980 changes in firm financial behaviour and investment. Shareholder orientation, particularly in the USA context, is an increasingly well-developed behavioural channel tying changes in firm behaviour to financial outcomes. Nonetheless, it is important to recognize that trends like an expansion in NFC financial asset holdings and/or financial profits can have different implications for fixed investment in different contexts. For instance, financial earnings may crowd out investment if driven by expanded opportunities to earn high returns on liquid assets in the context of uncertainty and the presence of credit constraints. However, the same ‘crowding out’ may not hold if financial asset holdings reflect an expansion in the scope of NFC activities towards involvement in banking services. Thus, space remains to build on this existing literature, to draw links between observed changes in firm financial structure and the specific changes in firm objectives, constraints, or activities that generate these outcomes. Doing so – particularly given that the term ‘financialization’ denotes a broad and wide-reaching process of structural change – opens scope for the possibility that different channels associated with financialization affect investment in different ways.

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