When a single company pursues a bad strategy, it is reasonable to blame bad management. When thousands of companies pursue the same strategy, it is time to look for broader systemic forces at work.
So it goes with corporate short-termism, the act of returning cash to shareholders through buybacks and raised dividends rather than deploying it in a way that potentially yields distant returns.
Too much short-termism throughout the US expansion is among the reasons often given for lacklustre investment growth despite healthy corporate profits.
Economists worry that this investment drought will continue depressing productivity growth. Market strategists worry equities will collapse once the buyback binge is over. Governance experts worry that skewed corporate pay schemes have led executives to obsess about quarterly earnings multiples.
There is a reason you have not heard as much lately about corporate short-termism — there seems to be less of it. The amount authorised for US buybacks declined 15 per cent in the year to the end of April from the same period last year, according to Birinyi Associates. Meanwhile, growth in US non-residential investment started rebounding strongly at the end of 2016 after decelerating for four of the past five years. Economists at Goldman Sachs and Deutsche Bank expect capital expenditures to keep rising.
But that is uncertain, and it is worth looking more closely at what causes companies to give investors their money back in lieu of other options. A useful prism through which to understand the issue is to consider the other options themselves in the context of the current recovery — the slowest-growing US expansion of the postwar period.
First, a company might use the money for fixed investment, superficially the most pleasing option. But what if opportunities are scarce, as would be expected in a stagnant economy? Excessive investment is wasted investment. In addition to managers possibly breaching their fiduciary duties, society does not much benefit from investments in buildings and equipment that make products nobody will buy.
Second, a company could theoretically just retain a large amount of cash and cash-equivalents on its balance sheet. This can make sense but has limits. Such a balance sheet is not costless, either for the company or societally. Non-financial corporates are not asset managers. They mostly place their cash in safe assets.
In a low-rate environment, the yield on safe assets might fail to keep pace with inflation. The macroeconomic impact of companies choosing to hold so many safe assets is even more worrying. A safe asset shortage was a plausible cause of the last financial crisis, as investor appetite motivated the financial sector to create assets with the false appearance of safety. The bursting of this illusion sparked the early run on financial institutions.
Finally, a corporate could spend its cash to buy other companies. There is danger here, too. Consolidations only create net value under certain conditions, in the absence of which they are not necessarily preferable to simply giving investors the choice of where to allocate the money.
In times of sluggish growth, every choice is problematic. Then how best to compel corporates to spend their money on investing for the future? The answer is simple but not easy: make growth less sluggish.
Investment is obviously an input of economic growth. Variables such as an ageing capital stock, idle productive capacity and the emergence of dominant economic sectors can all influence investment trends.
But economists who use modern versions of so-called “accelerator” models have found that investment also appears to be very much a product of economic growth as well — and of expectations that growth will accelerate.
One such economist is Srinivas Thiruvadanthai of the Jerome Levy Forecasting Center, who notes that “growth has been tepid throughout this recovery and expectations of growth, gleaned from executive surveys and earning calls, have been subdued.”
Jason Furman, former chair of the former president Barack Obama’s Council of Economic Advisers, wrote in 2015 that by the accelerator view, “businesses invest because they expect consumers to buy their products in the future, not simply because they currently have high profits or substantial retained earnings”.
A virtuous cycle reveals itself whereby accelerating growth leads to more investment now, which leads to faster expected future growth, and so on.
Short-termism is a complicated issue and not all the criticisms are misplaced. But the single best thing critics can do is to spur policymakers to stimulate the economy using the available macroeconomic tools. Corporate long-termism is likely to follow.