Whose Capital; What Gains?: Why the U.S. Economy Needs to Change Incentives

If we fail to change the incentive structures of American management and financial markets, our nation’s long-term economic well-being and, with it, our national security, will suffer, writes Lawrence Mitchell. The crisis was decades, and perhaps more than a century, in the making, and is the result of many different factors that can be found in the historical record.

In this new paper, Mitchell argues that common stock has almost never been a source of permanent capital in American industry. And, he writes, the sources of capital gains has also dramatically shifted from the 1950s, when Merton Miller and Franco Modigliani, developed their famous dividend irrelevance theory, from corporate profits in the form of retained earnings to future profits in the form of velocity-induced trading gains. While both of these propositions may seem counterintuitive, the latter will seem plainly wrong, at least to devotees of efficient market theory. But the empirical correctness of the former proposition underlies the contemporary theoretical weakness of the latter.

The net results are that shareholders, or managers on their behalf, are gambling with debtholders’ money, and that the future profits of American industry are being spent today. Both call into question the sustainability of American industry and the future wealth of the United States.

Mitchell makes a number of recommendations in this paper, incuding:

  • Build long-term investing into the initial investment decision by developing a sliding scale capital gains tax, with highly punitive taxation for short-term trading, diminishing over time to tax forgiveness for long-term holding.
  • Include returning to largely insider boards (outside directors tend to manage by stock price) and making appropriate accounting changes to rely more heavily on cash flow than income statement accounting.

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