Everyone knows that there are lots of things wrong with the American economy. To name just a few problems: growth has been low and inequality high; the middle class is shrinking and not benefitting from increases in productivity; business investment is down and the financial sector is booming. There are many explanations for these problems—globalization, the rise of the information economy and the decline of unions—are but a few. But the problem with so many of the explanations that are, no doubt, true—is that there is very little that a policy maker can do about them.
In our new paper “More builders and fewer traders: a growth strategy for the American economy” we identify a handful of obscure but important shifts—in laws, regulations, and standard practices—which, taken together, have changed the incentive structure of leaders in American corporations. This set of incentives has led to short term behavior on the part of corporate leadership. These incentives are so powerful that once they became pervasive in the private sector, they began to have broad effects. No one set out to create this myopic system, which arose piecemeal over a period of decades. But taken together, these perverse new micro-incentives have created a macroeconomic problem.
There are four trends that constitute the architecture of modern short-termism: the proliferation of stock buybacks; the increase in non-cash compensation; the fixation on quarterly earnings; and the rise of activist investors. The effect of this system across the broad economy has been to reinforce short-term behavior on the part of corporate leaders. While cash distributed to shareholders as a share of cash flow has surged to a record high during the past decade, the share devoted to capital investment has fallen to a record low.
Unlike many of the broader developments that have contributed to our economic problems—these incentives can and must be changed. We recommend:
- Repealing SEC Rule 10-B-18 and the 25 percent exemption
- Improving disclosure practices
- Strengthening sustainability standards in 10-K reporting
- Toughening executive compensation rules
- Reforming the taxation of executive compensation
Changes such as the ones identified above will free funds for investments in employees as well as plant, equipment, and R&D. Thus a virtuous circle becomes possible: a more satisfied and productive workforce will boost growth, which in turn will permit CEOs and boards to raise wages while offering good returns on shareholder investment. For the first time in the 21st century, we could be growing together—not apart.