4 - Saving in a Corporate Economy

Summary

The ownership of firms is mediated by financial assets in a corporate economy. The Modigliani-Miller theorem and most macroeconomic models tend to play down the relevance of this financial mediation. Behavioral and institutional factors make it unlikely, however, that households ‘pierce the corporate veil’ and adjust their portfolios to offset changes in firms’ financial decisions and, as shown by (an extended version of) Kaldor’s ‘neo-Pasinetti theorem’, households as a group cannot declare their own dividends by selling shares if corporate retained earnings are raised. As a result, aggregate saving rates will be increasing in the share of profits, the retention rate out of profits, and the share of stock buybacks. Changes in household portfolio behavior also affect aggregate saving, but the direction depends on firms’ retention and buyback policies. In this setting, a tightening of credit constraints can lead to a protracted decline in aggregate demand, feedback effects from capital gains to portfolio choice can fuel stock market bubbles, and Tobin’s q becomes a poor indicator of the return to additional capital.