If you want companies to return less money to shareholders, then you should be able to defend an alternative choice for what they should do instead with their cash.
But in times of slow economic growth, all options are problematic. That’s the premise of my On Wall Street column from the Weekend FT, and it’s a direct extension of two earlier posts discussing the idea that investment is as much a function as a cause of weak economic growth. (I think it’s both.)
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.
The academic literature on all of these choices is deep and inconsistent. Arguments continue about if and when M&A adds value (and whether buyer or seller captures more of it), the effects of excessive investment, and whether companies are too short-termist in the first place.
Yes, I’m aware of the blockbuster McKinsey report from earlier this year showing that companies committing to the long-term do outperform. I share the same hesitations about it — a simple correlation vs causation issue — that Larry Summers has already expressed.
Not all criticisms of short-termism are necessarily off the mark. A tax system that incentivises companies to keep earnings offshore and tap debt markets to pay for buybacks, effectively using their offshore holdings as collateral, is one that needs reform.
There is also evidence that companies in recent decades have increasingly used more of their retained earnings and borrowed money to return money to shareholders. This trend might have more to do with a shifting expectation of optimal capital allocation, perhaps influenced by financialisation or globalisation or something else, than with short-termist thinking. But I’m really not sure, and maybe the two ideas shouldn’t be thought distinct. See also the Kaplan paper below on the long history of this complaint.
Even acknowledging the criticisms, we’re left with the question of what to do. The simplest answer is that monetary and fiscal policymakers should first do much more to raise current and expected growth rates. If it is true that demand-side stimulus and supply-side productive capacity are less separable than earlier generations of economic models assumed, then aggressive policy strides will hopefully lead to a virtuous cycle in which each pushes the other higher.
This might not solve every problem related to short-termism, but it would offer a clearer picture of just how meaningful those other problems are. An economy at full employment is among other things an opportunity to answer questions about structural issues that are hazier in times of economic slack. Lingering questions about short-termism are very much included.
Relatedly, and in the spirit of continuing the debate, below are two recent studies on short-termism that I’ve recently come across and didn’t have space for in the column.
First, from Joseph Gruber and Steven Kamin, Corporate Buybacks and Capital Investment: An International Perspective…
In conclusion, we find little evidence that economies that have experienced larger shortfalls in corporate investment spending have experienced larger increases in share buybacks and/or dividend payments. It may be that these two developments are genuinely unrelated, and that even had investment opportunities around the world been more plentiful, we would still have seen increases in corporate buybacks. For example, corporations may be taking advantage of low interest rates and borrowing to finance buybacks, regardless of their profits and investment opportunities.
But it could also be that the recent relationship between buybacks and capital spending is not apparent at the aggregate, economy-wide level, and can only be identified using firm- and industry-level data, as in Gutierrez and Philippon (2016) and Lee, Shin, and Stultz (2016). Accordingly, more analysis of this issue is needed.
And from Steven Kaplan, Are U.S. Companies Too Short-Term Oriented? Some Thoughts…
There continues today to be much criticism of U.S. companies as too short-term oriented and not oriented enough towards innovation. Those criticisms are not new. They have a long history that goes back at least thirty-five years. If the short-term orientation were true and such a bad thing, its effects should have shown up by now.
But none of those effects have appeared. A short-term orientation has not showed up in lower corporate profits. It has not shown up in higher VC investments and returns. It may have shown up in higher PE investments and returns in the mid-2000s, but it does not appear to have been an issue in the last ten years. Finally, if short-termism is such a problem today, it should show up in low current P/E Ratios. Instead, the opposite is true. Current P/E ratios are historically high.
Overall, then, the criticism of U.S. companies (and their managers) seems overstated if not unwarranted.