A few weeks back, Hillary Clinton unveiled her proposed tax complication scheme and other proposals to combat “short-termism.” People generally being more conservative with regards to their own professions than other people’s professions, I was tempted to suggest that trusting Hillary (or any politician) to remedy whatever was ailing corporate America was like trusting a medieval doctor to cure…well, just about anything. You just know that whatever the ailment, the treatment will involve bleeding the patient. But recalling the above-noted bias, I realized that I was merely responding to quackery with quackery, and that I was in no better position to give Mrs. Clinton political advice than she was at giving anyone economic advice.
So I refrained from calling her out on her proposal, including addressing the irony of politicians accusing corporations of short-termism, and left it to the pundits to debate her prescriptions. What I didn’t expect is a spate of articles refuting her diagnosis, i.e., that corporate America was suffering from an acute case of short-termism.
In a Wall Street Journal editorial, “The Imaginary Problem of Corporate Short-termism,” Mark Roe of Harvard acknowledges the strong evidence that managers do often behave short-term in managing earnings. But he then highlights the fact that high-tech and biotech firms with no earnings at all can still command sky-high valuations, refuting the idea that investors ignore the long term, or fail to reward investments with long-term payoffs. Prof. Roe also notes that innovation often does not come from the big, public companies that accumulate all the cash and get all the attention, and that we don’t want these companies re-investing in business models that represent past success rather than future promise. Much better for them to recycle their cash to investors who can then find better returns in more innovative areas of the economy, such as private equity and venture capital. In short, Roe believes that the problem of corporate short-termism is vastly overblown.
In “The Short-termism Myth,” James Surowiecki makes similar points, acknowledging the same evidence of short-term behavior,* but then pointing out the plentiful other research showing how R&D in America has increased up over time, how we spend as much on R&D as our enlightened peers, and how companies are actually rewarded by investors for increasing R&D and punished for cutting it, all pointing to a much less myopic American management than is generally assumed.
In my own experience, large, public companies are becoming the worst place to expect the kind of innovation most likely to create the next big thing. Most of them can innovate well enough the work processes that enable them to become more efficient at high-volume transactions of established products. But if a large company wants to break into new markets, they are often better off buying that access via acquisition of an already well-positioned firm. If they want new product, they are very likely better off buying it from a smaller company that has already proved the idea (or just buying the whole company). In fact, large, public companies are often most helpful when keeping their cash far away from their internal capital budgeting wars that more often reward empire-building than value-creating innovation.
Some may look at Google as proof that big companies can innovate well beyond their initial unicorn success, but even there the jury is still out on how well and how long they can do that. In fact, their recent reorganization was designed precisely to add transparency to better enable a skeptical market to distinguish the value-added of their established search business versus their new ventures.
American innovation is driven by an entrepreneurial ecosystem that has evolved alongside the universe of large, public companies. This ecosystem, which exists nowhere else on earth, is not the product of intelligent design by lawmakers, but the product of a messy evolution driven by a law of economics that cannot be amended or repealed by Congress, i.e., that capital will ultimately seek out higher returns as surely as water travels downhill. Trying to channel the flow of capital in any direction away from the market preferences of millions of investors is generally wasteful and ultimately futile.
All of this is not to say that short-termism isn’t a problem. Surowiecki and Roe each note that managerial incentives may, in fact, hurt innovation, and I agree. Unfortunately, Mrs. Clinton wants to mess with executive compensation by doubling down on her husbands failed prescriptions by further complicating the tax code. Her faulty diagnosis of the problem guarantees that her prescribed treatments will fail.
* Both Roe and Surowiecki cite the groundbreaking research by Graham, Harvey, and Rajgopal