Wednesday, September 28, 2016

Biden: How Short-Termism Saps The Economy

Paying CEO's so much in stocks puts their focus on the share price instead of building for the long run.


By Joe Biden
The Wall Street Journal
September 28, 2016

Short-termism—the notion that companies forgo long-run investment to boost near-term stock price—is one of the greatest threats to America’s enduring prosperity. Over the past eight years, the U.S. economy has emerged from crisis and maintained an unprecedented recovery. We are now on the cusp of a remarkable resurgence. But the country can’t unlock its true potential without encouraging businesses to build for the long-run.

Private investment—from new factories, to research, to worker training—is perhaps the greatest driver of economic growth, paving the way for future prosperity for businesses, their supply chains and the economy as a whole. Without it robust growth is nearly impossible. Yet all too often, executives face pressure to prioritize today’s share price over adding long-term value.

The origins of short-termism are rooted in policies and practices that have eroded the incentive to create value: the dramatic growth in executive compensation tied to short-term share price; inadequate regulations that allow share buybacks without limit; tax laws that designate an investment as “long-term” after only one year; a subset of activist investors determined to steer companies away from further investment; and a financial culture focused on quarterly earnings and short-run metrics.

Consider the evolution in the structure of CEO compensation. In the 1980's, roughly three-fourths of executive pay at S&P 500 companies was in the form of cash salary and bonuses, and the rest in investment options and stock, according to an article in the Annual Review of Financial Economics. The Omnibus Budget Reconciliation Act of 1993 included a provision to link executive pay to the performance of the company. But it didn’t work as intended. By the time I became vice president, only 40% of executive pay was in cash, with the bulk being tied to investment options and stock. Now more than ever, there is a direct link between share price and CEO pay.

Performance-based pay encourages executives to think in the short-term. Ever since the Securities and Exchange Commission changed the buyback rules in 1982, there has been a proliferation in share repurchases. Today buybacks are the norm. According to economist William Lazonick, from 2003-12, companies on the S&P 500 spent 37% of their earnings on dividends and a full 54% on buybacks—leaving less than 10% for reinvestment.

This emphasis on returning profits to shareholders has led to a significant decline in business investment. Total investment as a share of the economy has fallen to about 11% today, down from a high of about 15% in the early 1980s, according to the Bureau of Economic Analysis. With interest rates at historically low levels, and business confidence in the U.S. far ahead of its economic competitors, there should be more investment, not less.

I am not blaming CEOs. The business leaders I’ve met over the course of my career want to build their firms and contribute to the economy, not simply send checks to investors or buy back their own stock. Sometimes they succeed. Other times the pressures to lift the short-run share price are simply too great.

As these short-term pressures mount, most of the harm is borne by workers. As any economist will tell you, productivity is typically the most important driver of increasing wages. But productivity will never flourish without businesses investing in endeavors like on-the-job training, new equipment, and research and development. In short, business investment boosts productivity, which lifts wages.

A continued economic resurgence requires solving the short-termism puzzle. The federal government can help foster private enterprise by providing worker training, building world-class infrastructure, and supporting research and innovation. But government should also take a look at regulations that promote share buybacks, tax laws that discourage long-term investment and corporate reporting standards that fail to account for long-run growth. The future of the economy depends on it.


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