How to Stop Short-Term Thinking at America’s Companies
U.S. companies are hyper-focused on quarterly earnings. What can be done to push them to invest more in the years and decades ahead?
There was a time, half a century ago, when what was good for many American corporations tended to also be good for America. Companies invested in their workers and new technologies, and as a result, they prospered and their employees did too.
Now, a growing group of business leaders is worried that companies are too concerned with short-term profits, focused only on making money for shareholders. As a result, they’re not investing in their workers, in research, or in technology—short-term costs that would reduce profits temporarily. And this, the business leaders say, may be creating long-term problems for the nation.
“Too many CEOs play the quarterly game and manage their businesses accordingly,” Paul Polman, the CEO of the British-Dutch conglomerate Unilever, told me. “But many of the world’s challenges can not be addressed with a quarterly mindset.”
Polman is one of a group of CEOs and business leaders that have signed onto the American Prosperity Project, an initiative spearheaded by the Aspen Institute, to encourage companies and the nation to engage in more long-term thinking. The group, which includes CEOs such as Chip Bergh of Levi Strauss and Ian Read of Pfizer, board directors such as Janet Hill of Wendy’s and Stanley Bergman of Henry Schein, Inc., and labor leaders such as Damon Silvers of the AFL-CIO, have issued a report encouraging the government to make it easier for companies to think in the long-term by investing in infrastructure and changing both the tax code and corporate governance laws.
“America’s incentive system for long-term investment is broken,” the report argues.
Data bears this out. The average holding time for stocks has fallen from eight years in 1960 to eight months in 2016. Almost 80 percent of chief financial officers at 400 of America’s largest public companies say they would sacrifice a firm’s economic value to meet the quarter’s earnings expectations. And companies are spending more and more on purchasing their own shares to drive stock prices up, rather than investing in equipment or employees.
Polman, who has been the CEO since 2009, told me that he sees business leaders managing spending from quarter to quarter, and pushing sales at the end of quarterly reporting periods if numbers are off. (This dynamic backfired at Wells Fargo, where employees pressured to meet quarterly targets opened accounts without customers’ permission.) Companies engage in “financial manipulation,” he said, to post better quarterly profits, and don’t spend money on costly investments that might make their businesses do better in the long term. Business leaders, afraid that shareholders will oust them if quarterly profits dip, aim for earnings at the expense of anything else. (For an in-depth look at one company that slashed research at the demands of investors, read my story on DuPont.)
“The strategy ends up being focused on the shareholders versus other stakeholders,” he told me. “If ultimately the purpose of a company is maximizing shareholder return, we risk ending up with many decisions that are not in the interest of society.”
There are a few reasons why short-termism has become more prevalent in America. There’s a growing culture of analysts and traders obsessing over a company’s quarterly performance, and panicking if a company posts poor quarterly results. This culture has been enabled by the availability of information about companies on the Internet and television, but it has also arisen because traders’ compensation is tied to how their holdings perform every year. The recession amplified this culture—so many funds lost money during that time period that they, too, began encouraging the people who manage their money to try and make it up in the short term. Often shareholders advocate against leaders of companies that may post a year of poor profits, even if that company could perform very well over a five-year period. CEOs and other executives often have their pay tied to annual performance, meaning they personally benefit from short-term profits too.
The Aspen Institute and its signatories have come out with a framework that they hope will discourage this kind of short-term thinking. Short-term thinking is bad for America, they say, because the country’s economic health depends on long-term investments that will pay out over time. What’s more, they argue, short-term thinking shouldn’t be paramount for the majority of investors; most equity is held by pension funds and other institutional investors who need their assets to perform well over the long haul. Large institutions hold nearly 70 percent of all equity issued in public markets today, up from 8 percent held by such institutions in 1950.
Many of the recommendations revolve around the policies that influence how companies spend their money. Currently, for instance, companies can defer taxes on foreign income until they repatriate that income, which discourages them from bringing the money back into the U.S. If the U.S. taxed multinational firms based on the share of worldwide sales that occur in the U.S. (a policy called formulary apportionment), that might discourage firms from locating operations overseas simply to lower their tax burden. Another tax change would be to allow “bonus depreciation,” a policy that would allow half of investment in equipment to be deducted immediately, rather than over a period of time. This was a policy enacted during the stimulus; a 2013 bill sponsored by Harry Reid proposed making it permanent.
The signatories also call for increased government spending so that companies can feel secure that they’re operating in a country that supports investment and productivity. This includes $200 billion of infrastructure investment per year. “If the airports are crummy and basic transportation is inadequate, we’re not supporting the system that makes it possible for goods and people to move easily,” Judy Samuelson, the executive director of the Aspen Institute’s business and society program, told me. The government could also raise money for research through a financial transactions tax, which would simultaneously curb the rapid trading done by some on Wall Street to earn quick money rather than invest in companies for the long term, the report argues.
Some of the recommendations focus on other ways to incentivize investors to hold onto assets for longer. Currently, assets held for less than one year are taxed as income but assets held for a year or more are treated as long-term investments and taxed at a lower rate of 15 percent. Increasing the amount of time that investors must hold an asset so that it can be taxed as a long-term holding could encourage more investors to think about the long-term, the report argues. An alternative would be to tax holdings on a gradual scale, in which assets held for a short time are taxed at a higher rate, and those held for a long time are taxed at a lower one.
Perhaps most compelling of the American Prosperity Project recommendations are those that companies can undertake on their own. After all, Congress has been and will likely be locked in gridlock going forward, and it’s doubtful it will take up bills that address corporate taxation or tax incentives in the new session. So instead there are recommendations in the report that individual companies can implement, if they truly want to put an end to short-termism. They include giving enhanced shareholder voting rights to investors who hang onto stocks for the long term, and voting on executive pay in a longer time frame so that executives’ incentives aren’t aligned with the need to post big quarterly gains. They also include discouraging short-term earnings guidance so that companies can focus more on the long term. Companies can, after all, refuse to issue earnings guidance, and only share financial information when they issue quarterly reports and other financial statements.
There are a few companies that have already tried to undertake some of these recommendations on their own. Unilever is one. When Polman became CEO, in 2009, he told investors that Unilever would stop issuing quarterly earnings guidance so that the company could focus more on the long term. The market punished Polman for doing so; According to Bloomberg, Unilever stock dropped 22 percent after his announcement compared to the 16 percent experienced by The Financial Times Stock Exchange 100 Index. Since then, the company has taken on some longer-term ideas, buying companies including Seventh Generation and Dollar Shave Club, and investing over a billion dollars in its U.S. factories.
It may be difficult to get other companies to follow. After all, few other company CEOs likely have a worldview similar to that of Polman’s, who is well-known for his independent streak.
“Ultimately, the purpose of a company is to serve society, and in doing so shareholders will equally benefit over time,” he told me. Many heads of companies, by contrast, believe that they have a duty to serve shareholders, and hope that the company will benefit over time. This is a mistaken assumption—as Cornell professor Lynn Stout has argued in her book, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public. CEOs think they have to put shareholders first, but they can put the interests of society first, if they choose. Still, many CEOs personally benefit when they act on behalf of shareholders; the way they are paid and evaluated depends on short-term success. It’s likely that their incentives will need to change before they act to stop short-termism on their own.