Does the Law of Diminishing Return Drive Down Return on Equity Investments?

This paper examines whether the aggregate investments in corporate equity in the U.S. yield lowering per-unit return for the period 1950-2009. We measure the per-unit return on aggregate equity investment as the ratio of the annual aggregate value of after-tax corporate profit of nonfinancial firms to the annual aggregate market value of stock issued by nonfinancial firms using data from the “Flow of Funds Accounts of the United States”. Consistent with “the law of diminishing return”, our analysis provides an empirical evidence of statistically significant decline in per-unit return on aggregate equity investments for the sample period. In context of this result, it appears that recent market-wide falls in stock prices of 2000 and 2008, triggered by dotcom and housing market bubble bursts, can be explained as manifestations of market adjustments to lowering expectations regarding return on investments in corporate equity