Short-term thinking undercuts corporate value, worker prosperity
By Neera Tanden
Economic indicators are good. Unemployment is below the historic norm. The deficit is down. And we have higher growth than the rest of the developed world. Yet Americans are overwhelmingly negative about the economy. This gloomy mood about the economic future is reflected in polls showing that three out of four Americans think the country is on the wrong track. So why are people so angry?
The answer: wages are stagnant. Middle-class incomes have been virtually flat for more than a decade despite productivity growth, and families are paying more for the foundations of a middle-class lifestyle, including health care, education, and housing. Yet corporate profits are at near record levels.
So why aren't wages going up even though companies are profitable? It’s possible the answer is a proliferation of short-term thinking.
Imagine you’re the CEO of a publicly traded company, and you are deciding whether to launch a new project you know will increase the value of your company in years to come. This seems like a no brainer; of course you move forward with an initiative that will add long-term value to your business, right?
Wrong. In a survey of financial executives, 55 percent said they would not begin a long-term project that was certain to reap profits if it meant falling short on a quarterly earnings report. More and more companies are focusing on improving short-term profits rather than building long-term value.
In the second half of the 20th century, business investment and after-tax profits moved together as a share of output. Since 2000, that trend has shifted. Business investment as a share of output has decreased from 5.4 to 3.7 percent. Meanwhile, the share of output going to profits has grown from 6.2 to 10.2 percent. Despite record profits and historically low borrowing costs, companies still aren't investing.
But the failure to invest in their own companies doesn't just hurt shareholders. It’s having a dampening effect on the entire economy. A recent report by the Center for American Progress connects challenges such as stagnant wages to the downward trend in business investment over the last decade and a half. In addition to its role in creating lower aggregate demand, a looser labor market, and stuck wages, this lack of investment has also slowed productivity growth — a necessary ingredient for middle-class income growth and increasing living standards. Conversely, when a portion of profits are reinvested in worker training, innovation, and capital projects increase productivity, which should drive economic activity and push up wages.
Technology has allowed UPS to save 98 million minutes of idle time, making its workers more productive.
Take, for example, UPS delivery drivers — the men and women who make e-commerce possible. UPS has invested in navigational technology that, among other things, helps UPS drivers avoid left turns. In its first year, this technology has allowed UPS to save 98 million minutes of idle time, making its workers more productive, as they can now deliver more packages in a day. These productivity gains should — with the right set of labor market institutions — translate into wage growth for the drivers while reducing the cost of deliveries for consumers. Investments in better technology or simply replacing broken equipment make workers more productive while increasing consumers’ living standards.
Unfortunately, the data show that corporate profits are funneled into this type of investment with less and less frequency. At a recent event hosted by the Center for American Progress, business leaders, economists, academics, and policymakers discussed whether a growing emphasis on the short-term is encouraging managers to undercut their own companies’ long-term economic health.
“The phrase long term-ism is fast becoming a part of the business dialogue.” — Blair Effron, partner and co-founder of Centerview Partners
“Quite simply… the responsibility of the business community is to strike the right balance between delivering returns for shareholders in the short term and investing in growth for the longer-term,” said Blair Effron, a partner and co-founder of independent investment and banking advisory firm Centerview Partners. “In fact, I think the phrase long term-ism is fast becoming a part of the business dialogue and business leaders absolutely worry that there’s an excessive focus on delivering bottom-line short-term earnings measured in quarters versus delivering bottom-line and topline earnings measured over years.”
Unfortunately, the evidence above backs this up. Companies are not investing as much they should be. What is causing the investment drought? Slow growth, especially since the financial collapse, has certainly played a role, but this trend of decline began in 2000. Growing voices in the business community postulate that equity markets ruled by short-term motives are influencing companies’ decisions to invest.
Because hedge funds are focused only on short-term gains, it is possible that thinking has bled over into the planning cycle of publicly traded companies. Since 1950s, the average time investors hold a stock has fallen from 6 years to 6 months. Meanwhile, executives are principally compensated with stock or stock options today, unlike 20 years ago when they were paid mainly in cash. This creates an incentive for executives to manipulate share prices to maximize their profits when options vest, or to spend billions on share buybacks instead of investing in human capital or innovations that will improve their companies’ long-term fortunes. From 2004 to 2013, the 454 largest publicly traded companies spent $3.4 trillion buying their own stock.
If it’s true that the short-termism of markets has translated into short-term thinking by corporations, the question becomes: What can business leaders and policymakers do to reverse the trend? And what can they do to encourage the types of investments in worker training, innovation, and capital outlays that keep our businesses competitive around the globe and contribute to our economic development here at home?
Managers will always have information and influence the public won’t have. But rigorously enforcing existing insider trading laws will help even the playing field. We should also consider giving greater influence to long-term shareholders in corporate elections, and reforming tax policy to discourage managers from focusing only on short-term profitability. A sliding capital gains tax would also reward long-term investment over short-term speculation. These changes can come, in part, from better public policy. But they will need the support of responsible business leaders.
Eighty-six percent of board members and executives surveyed said long-term thinking would actually strengthen companies’ financial returns and innovation.
It shouldn't be hard to get business leaders on board with a return to long-term thinking. Eighty-six percent of board members and executives surveyed said long-term thinking would actually strengthen companies’ financial returns and innovation. It’s time for the business community to step forward and work with policymakers on solutions that will benefit companies, families, and the economy.
Neera Tanden is the President of the Center for American Progress.