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New research finds that major U.S. corporations are growing by buying up their competitors rather than generating new ideas.

The U.S. economy is in a perplexing place. The stock market is booming, yet overall growth is weak. In a new paper, James D. Paron, an assistant professor of finance at Stanford Graduate School of Business, argues these trends aren't contradictions but two sides of the same coin.

According to , the equities boom has less to do with innovation and more to do with wealth being concentrated in the hands of established corporate giants. He finds that as innovative ideas have become harder to find, companies have scaled back on R&D and focused on buying up their rivals. As bigger, more efficient firms dominate the market, they have pushed up stock prices—even as the slowdown in new ideas drags on productivity and growth.

The study is published in The Wharton School Research Paper.

"The value of the stock market rises because the most productive firms cut back on research and spend more on acquisitions," Paron says. "That concentrates more of the economy into the hands of high-productivity, high-valuation firms."

The divergence between the stock market's performance and the larger economy has widened over the past 50 years. U.S. gross domestic product growth has slowed while stock valuations have soared, far outpacing overall output. Paron shows that the stock market's rise since the 1970s is not because individual companies became more valuable relative to their own sales. Instead, it is because the biggest, highest-valued firms grabbed a larger share of the market.

This trend is underpinned by a decline in innovation productivity, the amount of economic growth generated from each dollar spent on research and development. Paron finds the measure has plunged by about 47% since 1975. "When innovation gets harder, firms spend less on R&D, which is why growth falls," he says.

Since 1975, innovation productivity, the amount of economic growth generated from each dollar spent on research and development, has plunged by 47%.

Behind this shift is a change in corporate strategy. Firms increasingly rely on mergers and acquisitions to drive their growth. Paron finds that M&A spending has doubled relative to R&D spending over the past 40 years, peaking in the late '90s and staying relatively elevated since. (Within companies, R&D intensity has fallen, but since firms that already spend heavily on research now dominate more of the market, the overall average looks higher.)

In the meantime, fewer new companies are entering the market to compete with the incumbents. (And more of those that do enter the market are seeking to be acquired by their bigger competitors.) From 1980 to 2018, the annual rate of new company entries fell from 12% to 8%, while the sales share of dominant firms climbed from 15% to 30%.

Gains go to the top

That matters because while shareholders enjoy richer returns, American households are worse off. Paron's study finds that living standards, as measured by the present value of consumption, including wages and the profits of new companies, stagnated between 1970 and 2020. Instead, the gains flowed to entrenched corporations at the expense of workers and companies that would exist if innovation were easier.

"For the typical consumer, there's little to no gain—they are worse off, with weaker growth and fewer new ideas," Paron says. "The real winners are the owners of the most productive big firms, who benefit disproportionately."

Paron also finds that weaker productivity explains about half of the fall in real interest rates since the 1960s. When innovation slows, investments generate lower returns, and interest rates come down to match. (Paron notes that his research cannot explain sharp swings in rates driven by monetary policy and business cycles.)

Beyond this study, Paron's research examines how financial markets interact with the broader economy. His recent work looks at what long-term shifts in the structure of the U.S. economy mean for growth, valuations, and wealth inequality. "I have sought to shed light on these macroeconomic trends by documenting new evidence from microeconomic data," he says.

He does not prescribe specific solutions to the "wealth of stagnation," but his findings point to tax and antitrust policy. Should tax policy steer companies toward research rather than acquisitions? Should regulators view mergers not just as corporate strategy but as a way to sidestep investing in innovation?

Paron acknowledges that there's a trade-off here. "There are plenty of reasons consolidation can be bad for the economy. It gives big firms more market power, letting them extract higher profits while paying workers less—a clear hit to labor." On the other hand, "M&A does shift resources to more productive companies and can even spur innovation among smaller firms hoping to be acquired."

It's a complex dynamic that helps explain why Wall Street is breaking records even as the broader economy shows signs of stalling.