American companies are thinking long term
Almost every day, US companies are criticized for focusing too much on the short run and not enough on the long run. Laurence Fink, the CEO of BlackRock, one of the largest money managers, recently wrote that “the effects of the short-termist phenomenon are troubling... more and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth”.
In other words, US companies are destroying value by not investing for the long run. Poor corporate governance and overly generous pay plans for CEOs that reward short-term behaviour are often cited as accomplices to short-termism. And politicians have taken notice. On her presidential campaign website, Hillary Clinton vowed to halt “quarterly capitalism”, saying, “We need an economy where companies plan for the long run.” She promised to change the tax code, curb shareholder activism, and restrain executive pay with the goal of refocusing corporations on long-term growth. Outgoing vice- president Joe Biden weighed in with similar sentiments in a Wall Street Journal op-ed in September.
At the same time, US companies are criticized for being very (and even, perhaps, too) successful. Corporate profits (after executive pay) in the US are at historically high levels and at historically high proportions of GDP. And the trend of increasing profits has not been a short-term one. US corporate profits have increased steadily since bottoming in the early 1980s. US companies arguably have taken advantage of technology and globalization to become increasingly profitable and efficient in the intervening period.
The early 1980s is precisely the time that most observers believe finance and shareholder value maximization became ascendant. It is also the time that Wall Street and the financial sector began to grow substantially—both in the US and internationally. The early 1980s also coincided with the rise of management consultants who spread techniques across US firms and across the world. In 1980, consulting firms were relatively new and relatively small. Today, McKinsey & Company has offices in more than 60 countries, Boston Consulting Group in more than 40.
The trend of increasing corporate profits goes back to the early 1980s, a time that saw the rise of Wall Street, management consultants and globalization in the financial sector.
Although many would think the results achieved by US companies have been tremendous, the efficiency and profitability of those companies are perceived to have contributed to the increase in income inequality by benefiting those at the top of the income distribution while keeping wages lower for the rest.
In other words, the fact that the great success of US companies has not been distributed uniformly has created political challenges.
You may have noticed that there is a conflict. How can US companies excel at generating increasing profits over a 30-year period and, at the same time, be mortgaging the future for the short run? The only way to reconcile the two criticisms is to believe that US companies have become increasingly short-termist just recently. But that is simply not the case.
In fact, the criticism that US companies are plagued by short-termism and poor governance has a long history. In the early 1980s, Harvard’s Robert H. Hayes and William J. Abernathy wrote an influential article criticizing American companies for being too short-term oriented: “By their preference for servicing existing markets rather than creating new ones and by their devotion to short-term returns and management by the numbers, many of them have effectively forsworn long-term technological superiority as a competitive weapon. In consequence, they have abdicated their strategic responsibilities.”
The thesis seems strikingly familiar today.
The argument was repeated in 1992 when Harvard’s Michael E. Porter wrote that “the US system of allocating investment capital both within and across companies is failing. This puts American companies in a range of industries at a serious disadvantage in global competition and ultimately threatens the long-term growth of the US economy”.
And the argument is being repeated today by the likes of Laurence Fink, Hillary Clinton and Joe Biden.
There is a big problem for the short-term crowd. “The short run” is normally taken to mean between one and three years, at most five years. It’s been more than 35 years since the publication of the Hayes and Abernathy article, and almost 25 years since the appearance of Porter’s. By any measure, today is the long run.
The implication of the short-termism argument is that in the longer run, because of a lack of investment, corporate profits will wither, things will go wrong, and poor management will be shown to have failed. So, today—according to the short-term perspective—US corporations should be in dire straits.
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But that is unequivocally not the case. The trend line has been unmistakably up. The uptrend began just around the time of Hayes and Abernathy and has continued since. This is evidence that the short-termists cannot explain. Nevertheless, short-termists such as Fink continue to repeat the mantras of the 1980s and ’90s.
Clearly, there’s an incongruity in claiming that US companies are both poorly governed and overly successful. And in fact, almost four decades after Hayes and Abernathy’s complaint, the data strongly suggest that concerns about short-termism and poor governance are overblown. The aggregate evidence is much more favourable for the efficiency argument.
Rather than being criticized, US corporations should be congratulated.
And the shareholders of US companies have not been the only beneficiaries. As US corporations have taken advantage of technology and globalization, the global outcomes have been impressive.
According to the World Bank, in 1980 the number of people living in extreme poverty globally was around 2 billion, some 44% of the world’s population, which numbered about 4.5 billion. By 2012, that figure had fallen to less than 900 million, or about 13% of the global population of 7 billion. The World Bank projected last year that for the first time the number of people living in extreme poverty around the globe was expected to have fallen below 10%. While causality is hard to prove and many factors have contributed to this result, US companies have played an important role in these outcomes.
So, why is there criticism for success and short-termism? While the success and efficiency of US corporations have been good for the people at the top and for people in developing countries such as China and India, they have not been so good for the people in the middle in developed economies. That has fuelled frustration and anger, which helps explain the Donald Trump and Bernie Sanders phenomena, Jeremy Corbyn’s election as leader of the UK Labour party, the UK’s vote to leave the European Union, and the rise of populist politics more generally.
In addition to the anger, other pieces of evidence encourage the short-termists. For example, a 2005 academic paper surveying 401 financial executives found that 78% would sacrifice long-term value to smooth earnings. I have no reason to doubt that result. Corporate leaders face strong pressures, some of which may lead them to take actions that flatter the short run at the expense of the longer run. However, it is also clear that some of the same short-term pressures can actually prompt companies to become more efficient. It is not at all clear which of these effects dominates. Again, the trend line suggests that even if some companies are obsessing over the short run, the long run is taking care of itself.
Another argument that is regularly used by those who lament short-termism relates to buybacks. This group contends that companies buy back their own stock to boost their share prices in the short run, regardless of the long-term impact. This argument is something of a non sequitur. It suggests that in a buyback, the money simply disappears rather than going to investors who spend it or use it to make other investments. It also suggests that companies that don’t need money should invest it anyway, rather than give it back to shareholders.
For observers such as my colleague Luigi Zingales at Chicago Booth, part of the explanation is crony capitalism, in which incumbent corporate giants use their political connections to shape the system in their favour. There may be industries that fit that description—telecoms being one possible example—but they are the exception rather than the rule. The US’s biggest, most valuable companies are Apple, Google, Amazon, Facebook, and the like. They have used market forces to their advantage, are profitable as a result, and certainly now enjoy some market power. But they didn’t attain that position through the machinations of some corporate illuminati. They have gotten to where they are in part because they are operating in sectors where there are network effects.
At the same time, the short-termers ignore a lot of evidence that defies their position and their fears. Amazon has been highly valued for many years despite the fact that it was losing money for much of that time. Amazon invested for the long run and has been richly rewarded for doing so. Similarly, US biotechnology companies, which have made huge progress in innovation and push the boundaries of science, are routinely valued in the billions of dollars often before they actually have any drugs for sale. If the market were really as short-termist as critics claim, that industry would not exist.
So short-termism is not the bogeyman it is often made out to be. The argument does not fit the evidence. And it is the same evidence that leads to the second, converse, criticism made of corporate America: that rather than being poorly governed, companies have been relentlessly and successfully efficient. While that efficiency has contributed to tensions in the developed world, the global effect has been overwhelmingly positive.
Steve Kaplan is Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at Chicago Booth.
This article first appeared in the Winter 2016-17 issue of Chicago Booth Review.