Capital allocation is a senior management team’s most fundamental
responsibility. The problem is that many CEOs don’t know how to allocate
capital effectively. The objective of capital allocation is to build long-term
value per share.
Capital allocation is always important but is especially pertinent today
because return on invested capital is high, growth is modest, and
corporate balance sheets in the U.S. have substantial cash.
Internal financing represented more than 90 percent of the source of total
capital for U.S. companies from 1980-2015.
M&A, capital expenditures, and R&D are the largest uses of capital for
operations, and companies now spend more on buybacks than dividends.
This report discusses each use of capital, shows how to analyze that use,
reviews the academic findings, and offers a near-term outlook.
We provide a framework for assessing a company’s capital allocation
skills, which includes examining past behaviors, understanding incentives,
and considering the five principles of capital allocation.