Companies are increasingly passing up profitable investments because of financial market pressures and executive compensation incentives. These activities yield short-term returns but put their—and the nation’s—long-term economic health at risk.
The growing short-term focus of public companies leads to less investment, resulting in fewer jobs and lower wages. At the same time, companies’ continued failure to take into consideration long-term sustainability puts current investments and future economic growth at risk.
But short-termism is not inevitable. Here are five steps that Congress and the U.S. Securities and Exchange Commission, or SEC, can take to nudge companies to focus on the long term.
1. Fix how the tax code treats executive pay
The tax code lets companies write off their employees’ pay as a business expense, reducing their corporate tax bill in the process. In 1993, Congress passed a law that only permitted companies to write off compensation above $1 million if it was based on performance.
The law has encouraged companies to pay executives with stock rather than salary. As a result, the performance pay provision has led managers to focus on manipulating their companies’ short-term stock price rather than creating long-term value. One study, for example, found that CEOs time favorable news to release to the public when their options vest, temporarily pushing up the stock price right when they sell their shares.
The performance-based pay provision is a creation of Congress; therefore, Congress must fix it. One option is to require that tax-deductible pay above $1 million be based on long-term performance by, for example, specifying that options vest over 5 to 10 years. Another option, proposed by Sens. Jack Reed (D-RI) and Richard Blumenthal (D-CT), is to scrap the performance pay requirement altogether.
2. Expand environmental, social, and corporate governance disclosure
As corporations become more complex, investors are demanding more information to fully understand companies’ operations and their approaches to environmental, social, and governance, or ESG, matters—such as the environment and climate change, tax strategies, political spending, human capital and workforce issues, human rights, and financial stability risks. And it’s easy to understand why: These issues increasingly affect investors’ long-term bottom lines. A recent report found that investors overwhelmingly told the SEC that they need more and better information on the entire range of ESG issues.
To take just one example, the way companies report investments in worker training creates a powerful bias toward short-term approaches and against the long-term interests of businesses, workers, and investors. Worker training falls under Sales, General, and Administrative expenses, an accounting category that includes overhead costs such as paper clips and printer paper. Naturally, investors seek out companies with low overhead, giving executives strong incentives to reduce it. Yet quality workforce training enhances workers’ productivity and firms’ long-run profits.
The Center for American Progress has proposed requiring firms to disclose their investments in worker training, similar to how they disclose their spending on research and development. This would remove the perverse incentive executives face to cut productivity-enhancing investments in their workforce.
3. Eliminate the safe harbor on stock buybacks
The primary way that firms have disinvested—that is, cut their investments to pay out money to shareholders—is by using their earnings to buy back their own stock. Research by William Lazonick of the University of Massachusetts Lowell finds that America’s largest companies spent $3.4 trillion on stock buybacks between 2004 and 2013, representing 51 percent of their profits. This practice is attractive to companies because it allows them to meet their earnings-per-share targets by reducing the number of outstanding shares. It is also driven by pressure from certain powerful and prominent shareholders.
Similar to the move toward performance pay for executives, the stock buyback explosion was a direct result of policy. In 1982, the SEC adjusted Rule 10b-18 of the Securities Exchange Act to provide firms safe harbor protection from insider trading charges when firms purchase stock on the open market. The SEC should repeal this safe harbor. While returning money to shareholders sometimes makes sense, it is far from clear that buybacks are an appropriate use of excess cash.
4. Grant proxy access to long-term stockholders
Another way to encourage firms to focus on long-term value is by empowering long-term shareholders. Granting them proxy access—the right to place their own nominees on the proxy card used to elect their company’s board of directors—would rebalance the playing field between long-term shareholders and increasingly short-term-focused managers and hedge funds. While some progress is being made through private shareholder initiatives, the SEC can do more to help support the interests of long-term investors.
5. Increase business investment by restoring aggregate demand
Lastly, the incomplete economic recovery from the Great Recession is one of the most important, yet most underappreciated, reasons for the shortfall in investment growth. Research by the International Monetary Fund shows that persistently weak demand has been a key driver behind the slowdown in business investment.
Keeping interest rates low and dramatically expanding the level of fiscal investment—for example, through improving infrastructure—can help raise aggregate demand. This would lead companies to increase their own private investment, since they would expect stronger future sales. While not a solution to the problem of short-termism specifically, raising demand would help address the shortfall in investment growth.
Conclusion
Companies’ increasingly short-term focus is not just a problem for Wall Street; it also means fewer jobs, lower wages for middle-class Americans, and greater unmitigated risks for society, such as climate change. Policymakers can take the above steps to refocus companies on creating long-term, sustainable value.
Brendan V. Duke is the Associate Director for Economic Policy at the Center for American Progress. Andrew Schwartz is a Research Associate on the Economic Policy team at the Center. Andy Green is the Managing Director for Economic Policy at the Center.