Has the Stock Market Become Less Representative of the Economy?

In the summer of 2020, with the U.S. economy bearing the impact of the COVID-19 pandemic, the unemployment rate was as high as it had been any time since 1948, and the NASDAQ and the S&P 500 indices reached their highest values ever. This dramatic difference in trajectories between unemployment and the stock market raises the questions of how much the stock market reflects the health of the American economy and whether in recent years it does so less than it used to. In a new paper, we explore these issues for the period 1950-2019 for a subset of our data and for the period 1973-2019 for most of the data. We investigate how the direct contribution of listed firms to employment and GDP evolves and find that listed firms contribute less to employment and GDP in the 2010s than in the 1970s.

For public corporations, employment data is available for most corporations annually since the early 1970s. We find that, from 1973 to 2019, the percentage of employees working for public firms is highest at the start of the sample period and falls sharply in the 1980s. At the beginning of that period, more than 41.4 percent of non-farm workers in the private sector work for public firms, but in 2019, that percentage is 29 percent. In 2019, the percentage of non-farm workers in the private sector working for public firms is the lowest for our sample period for industrial firms, and for all firms, including financial firms, it is the lowest except for 1989 and 1990.

We create a measure of unrepresentativeness to capture how poorly market capitalization serves as a proxy for a firm’s contribution to employment over time. For each firm, we measure the absolute value of the difference between the firm’s market capitalization as a share of the market capitalization of the stock market and the firm’s employment share among public firms, defined as the firm’s employment divided by the employment of all stock-market firms. The measure of unrepresentativeness is proportional to the sum of these differences. This measure follows a w-shape, with its lowest values in the 1980s and 1990s and its highest values in the 1970s, around 2000, and in the recent past. The stock market is more unrepresentative at the end of our sample period with respect to employment than at any time except around the year 2000.

Another way to show that market capitalizations are not instructive about firms’ contribution to employment is to estimate how much of the variation in market capitalizations can be accounted for by variation in employment. We find that from 1973 to 2019 a firm’s employment never explains as little of its market capitalization as it does in 2019. In most years in the 1970s and early 1980s, firm employment explains more than 50 percent of the variation in market capitalization. In each of the last four sample years but one, firm employment explains less than 20 percent of the variation in market capitalization.

The contribution of public firms to GDP is higher in the 1970s than in the 2000s. Using the same approach to measuring unrepresentativeness as with employment, we construct a measure of unrepresentativeness for value added. The stock market’s unrepresentativeness for value added follows a w-shape, with unrepresentativeness high early in the sample period, around 2000, and late in the sample period. In contrast to employment, the unrepresentativeness at the end of the sample period is less than at the beginning of the sample period. Finally, we examine how well our measure of firm value-added explains the cross-sectional variation in market capitalizations.  We find that variation in value-added best explains the variation in market capitalization in the late 1970s and early 1980s. While employment explains less of the variation in market capitalization in the 2010s than in the 1970s, the same is not the case for value added. The variation in value-added accounts for the variation in market capitalization less well at the end of the sample period than in a number of years, but it does so better than in the period from 1988 (1991 for industrial firms) to 2003.

To understand why the stock market has become less representative of the U.S. economy over time, we investigate how the economic importance of industries evolves. Not all firms are equally suited to be public firms. Hence, a shift from industries where firms find a stock market listing to be especially valuable to industries where firms typically prefer not to be listed could lead to a decline in the economic importance of listed firms. The U.S. Bureau of Labor Statistics (BLS) publishes employment data for broad industry categories, referred to as supersectors. We use these data to show that there is a straightforward explanation for the decline in the employment contribution of public firms.

A stock market listing is generally more valuable for manufacturing firms than for firms that provide services. Manufacturing firms have to raise capital to finance plants and equipment. Manufacturing firms that are successful become large with many shareholders. Service firms often have small funding needs for plant and equipment. Perhaps more importantly, they typically have few employees and, for many, their most important assets, their employees, walk out of the door at the end of every business day. During no time in our sample period is the percentage of employees working for listed manufacturing firms less than 60 percent of employees working for listed and unlisted manufacturing firms combined. In 1973, manufacturing is the supersector with the most employees in the US economy, but over the period 1973-2019 its number of employees declines by more than 30 percent even though the size of the economy increases substantially.

The supersector with the highest employee growth over this period is education and health services. In 1973, the workforce of this supersector is 27 percent of the workforce of manufacturing. In 2019, its number of employees is 2.4 times the number of employees of the manufacturing supersector. Education and health services has 3.6 percent of employees working for listed firms in 2019 in contrast to the manufacturing supersector, which has 79.6 percent of employees working for listed firms. Had manufacturing employment grown as the employment of education and health services did, the share of total employment represented by listed firms would be as high in 2019 as in the 1970s.

Finally, we investigate the contributions of the largest market capitalization firm and of the top-three market capitalization firms to the economy. The share of the stock market capitalization of the top market capitalization firm is consistently much higher before 1980. Strikingly, from 1950 to 2019, only seven distinct firms have the top market capitalization in at least one year. Only two of these firms, General Motors and AT&T, ever have the largest number of employees in the U.S. The percentage of U.S. non-farm payrolls represented by the largest market capitalization firm declines steadily over time, so that it is at its lowest in the 2000s. The percentage of U.S. GDP represented by the largest market capitalization firm is also lower in the 2000s than before 1980. The contribution of the top market capitalization firm to the economy in 2019 is a fraction of GM’s contribution in 1953.

This post comes to us from professors Frederik P. Schlingemann at the University of Pittsburgh and René M. Stulz at The Ohio State University. It is based on their recent article, “Has the Stock Market Become Less Representative of the Economy?,” available here.

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