Are U.S. Companies Too Short-Term Oriented? Some Thoughts
In the first article of our Fall 2018 issue Steve Kaplan notes that today’s widespread criticism of U.S. companies as shortsighted and ever willing to sacrifice their future for near-term profit is by no means new. As the author of this article shows, such charges of short-termism have a long history that goes back at least 40 years. But as he goes on to point out, if these claims were warranted, then the effects we have been warned about all these years would surely have shown up by now.
But it is difficult to find evidence of such effects. For example, a short-term orientation has not been reflected in any erosion of corporate profitability over time. As the author reports, the ratio of U.S. corporate profits as a percentage of U.S. GDP has not only been on a generally upward trend since the early 1980s, but has never been higher than in the past few years. And corporate spending on R&D has also gone up sharply during this period, from 1.1% of GDP in 1977 to 1.7% in 2016. What’s more, evidence of short-termism has not shown up in either higher amounts of investment, or higher rates of return, by venture capitalists and private equity firms, which are both in a good position to profit from widespread corporate failure to pursue valuable growth opportunities.
Nor do stock market investors appear to encourage corporate short-termism, given their willingness to fund IPOs of companies with no previous earnings, and to assign high price-earnings multiples to companies, like Amazon and Tesla, whose reported earnings have been modest at best. What’s more, the fact that today’s P/E and CAPE ratios are at relatively high levels suggests that the market continues to expect significant rates of growth by U.S. companies.
Some critics, to be sure, have argued that the high level of corporate buybacks and other distributions of cash, when combined with today’s near-record corporate cash holdings, provide clear evidence of a widespread failure of companies to invest in their future. But as the author notes, such distributions in fact represent a fairly small fraction—only around 20%—of after-tax corporate net income after infusions of new debt and equity capital are also taken into account.
Authored by Steve Kaplan