An Access Advertising EconBrief:
Hillary on CEO Short-Termism: Three Views
Among the mob of current candidates for President of the United States, the one most familiar to Americans is Hillary Clinton. As the First Lady to President Bill Clinton, she was a de facto Presidential advisor. She enjoyed official status as head of his proposed realignment of the nation’s health-care system. Her subsequent stints as U.S. Senator and Secretary of State kept her in the public eye.
Still, surprising as it seems, she faces the task of making her views known to voters during the current campaign. Mostly, this derives from her desire to downplay her past associations. Bill Clinton’s policies no longer resonate with her current constituency in the Democrat Party. Her health-care assignment was a disaster and she must find a way to dissociate herself from ObamaCare, so that subject is taboo. Thus, she finds herself in need of a political-personality makeover. Fortunately for her, personal reinvention is a Clinton family specialty.
Mrs. Clinton’s maiden voyage of reinvention was a recent speech in which she proposed to diagnose the ills of America business. She located the source in the CEO’s suite. The problem is that America’s CEOs are obsessively focused on short-term business results to the neglect of long-term performance. They are engaging in dividend payouts and stock buybacks rather than investing earnings to promote future growth. Having diagnosed the illness, she provides the cure; namely, higher capital-gains taxes with selective exemptions and reductions for “certain” businesses, communities and investments.
During an election cycle, any proposal advanced by any candidate receives predictable reactions. Opponents reject it scornfully and indignantly, impugning the candidate’s motives and qualifications. Supporters embrace it sincerely and naively, taking its expressed motivations at face value and its effects for granted.
Unless an observer has expert knowledge of the subject broached, it is hard to know which side to believe – assuming that one side or the other is believable. Mrs. Clinton’s inaugural policy position is as good an example as any to illustrate how to approach this sort of situation. To be sure, an economist has just the kind of expert knowledge needed to evaluate it. But the average person doesn’t. To complicate matters, that average person will be faced not only by the candidate, brandishing a bright, shiny policy statement, but by promoters and detractors of the candidate as well. What’s a mother to do in a spot like this?
Let’s use this early-season controversy as a test case. Having sketched Mrs. Clinton’s argument, we now amplify it by turning first to one of her supporters, then to a detractor.
The Case for Short-Termism: William Galston
In “Clinton Gets It Right on Short-Termism” (The Wall Street Journal, 07/28/2015), columnist William Galston declares that “Hillary Clinton has put her finger on a real problem: Too many CEOs are making decisions based on short-term considerations, regardless of their impact on the long-run performance of their firms.” As authority for his statement, Galston cites a public letter to the Fortune 500 CEOs by Laurence Fink, head of BlackRock, the world’s largest investment fund. Fink states that “…in the wake of the financial crisis, CEOs are “jeopardiz[ing] the ability of the[ir] compan[ies] to generate sustainable long-term returns” by eschewing investment spending for purposes of achieving future growth. Instead, they are choosing dividend distribution and stock buybacks.
Galston also cites historical data on earnings distributions for over 400 firms in the S&P 500 that were continuously present from 2004-2013. Stock buybacks comprised 51% of net income and dividend distributions were 35%, “leaving only 14% for all other purposes.” He compares this to 1981, when buybacks represented on 2% of earnings. In the interim, buybacks and dividends rose “inexorably,” to 25% from 1984-93, 37% during 1993-2003 and 47% in 2004-2013. “Some of America’s best-known corporations were returning more than 100% of their income to shareholders through buybacks and dividends” during the latter period.
Finally, Galston accuses CEOs of timing buybacks and company news releases so as to maximize their own income within company compensation formulas; for example, to take advantage of stock-option vesting.
The Case Against Short-Termism: Holman Jenkins
Holman Jenkins (“Hillary Vs. The Wisdom of Crowds,” The Wall Street Journal, 07/28/2015) characterizes Hillary Clinton’s remarks as “a speech to assure us that ultracompetent government can fix the failings of big business.” Those failings are not only those of CEOs, as cited by William Galston, but also those of shareholders and markets. Hillary is inveighing against “quarterly capitalism,” a philosophy she summarizes as “very real pressure from shareholders and the market to turn in good quarterly numbers.” Hillary claims, according to Jenkins, that it will take a “heroic policy effort to turn management’s attention back to ‘long-term growth, not short-term profits.'”
This policy effort consists of a complete revision of capital-gains tax policy. From a single capital-gains tax rate of 20%, Hillary would switch to 7 brackets ranging from zero (a special case applying to “certain” businesses, communities and investments) to 43.4% (on investments held for less than one year). Jenkins’ reaction to these provisions is to marvel at Hillary’s apparent belief that “America’s trouble is not enough rules, that the tax code is not complicated enough, that its distortions are not distorting enough.” This, he concludes, “seems insane.”
In promoting the doctrine of short-termism, Jenkins declares, Mrs. Clinton is spouting “an ancient jeremiad… a moldy-oldy from the 1980s,” for which there is “little academic evidence” or even “anecdotal evidence.” After all, he reminds us, the stock market shows great impatience with McDonald’s and endless patience with Amazon, both of whom have come up consistently short in the profits department in recent years. It seems that Hillary Clinton “would string syllables together in any order if she thought it would get her to the White House.”
CEOs and Capital Allocation: A Common-Sense View
So far, we have briefly outlined Hillary Clinton’s complaint against American CEOs and her policy proposal to improve corporate allocation of capital. We have viewed it from the perspectives of two commentators, a supporter and an opponent of Mrs. Clinton’s Presidential candidacy. Before providing the perspective of an economist, we should recall that millions of Americans do not have an economist on call. At present, there is no online economic advice hotline comparable to those offering medical and veterinary advice. How should the average American – who is unfamiliar with economic theory and logic – react when confronted with contradictory views on policy proposals such as Mrs. Clinton’s? After all, somebody without any expert knowledge simply sees and hears a candidate spouting off. Presumably, the candidate is motivated by his or her self-interest no matter how noble and public-spirited the candidate’s rhetoric may be. The commentators are nothing if not decided – this is what lawyers call a “swearing contest,” a “he-said, he-said” debate that is liable to give the average person a headache but not much in the way of enlightenment.
Saying that we should use our “common sense” is no good when common sense is not common or not commonly applied. The following is a process of reasoning that leads to the same conclusion as a priori economic theory.
If we are to accept Mrs. Clinton’s view, we must believe her story. It is roughly this: The CEOs of over 400 diverse corporations across America adopted the same policies toward capital budgeting – namely, reduction of investment spending in favor of dividend payout and stock buybacks – over a period of 30 years. Why? Mrs. Clinton says they did it to feather their own individual nests at the expense of their shareholders and, incidentally, the general public. Is this credible?
No. It is logical for the average person to assume that the CEOs must have been acting independently rather than collusively. (When we marshal the economic logic against short-termism, we will see why economists know this to be true.) Is it logical to think that a large group of people (mostly men, with a few women included) would abruptly begin to violate the canons of business responsibility and become steadily more irresponsible over time – simultaneously and while acting independently of each other? Tentatively, the answer is no, depending on whether any alternatively explanations for their behavior exist. What if they were responding to the same set of external circumstances, which caused them to react more or less identically because they all perceived those circumstances as requiring their change in behavior? Yes, that is surely a more likely explanation – the CEOs were responding to changes in the world around them which they all perceived as constituting a progressively less favorable investment climate. They were making the best of this unfavorable situation by distributing earnings to shareholders via dividends and share buybacks. They were not acting irresponsibly – although they could have been mistaken – they were guided by the force of circumstances as they perceived them.
Rather than simply rely in visceral instinct and emotion, observers should step back, take a deep breath and ask themselves if the candidate’s story makes sense. Mrs. Clinton’s story rings false in almost every way, the sole exception being her insistence that CEO’s time the execution of buybacks and release of corporate news to suit the vesting of their stock options or similar benefits. As paraphrased by William Galston, Mrs. Clinton’s allegations of CEO misbehavior are a variation on the age-old left-wing fallacy of the variability of human nature. Rather than being a constant, the political Left finds it convenient to assume that human self-interest varies dramatically up and down to suit their political needs. When something goes wrong with a government agency, policy or proposal, the Left can assign the blame to “greed” rearing its ugly head and prescribe a strong dose of big government as the cure. This is what Mrs. Clinton does here, with her call for seven different capital-gains tax brackets and her caveat that exemptions would apply to “certain” industries, communities and investments.
The average person knows from his or her own inner sense of human nature and personal experience of life that self-interest is a constant reality, not a virus that can suddenly flare up to epidemic proportions. Does that average person appreciate the multitude of circumstances that CEOs react to? No, probably not – but in this case the clue to evaluating Mrs. Clinton’s argument is right there in plain sight in William Galston’s article. He quotes Laurence Fink to the effect that the recent decline in investment spending and increase in dividend payouts and buybacks came “in the wake of the financial crisis” [emphasis added]. In other words, the CEOs didn’t just get greedy all of a sudden. They were reacting to events of 2008-2009 and looking to the future. And the average person can appreciate that, in retrospect, the CEOs’ anticipations for that future were pretty accurate.
Maybe the most important point to grasp is that this common-sense reasoning process has nothing to do, one way or the other, with what the average person thinks about any CEO’s personality. The CEO might be warm and compassionate, cold and heartless or anywhere in between – it doesn’t matter. The question is: What could reasonably motivate changes in CEO behavior, regardless of what kind of person the CEO is? The average person doesn’t know any CEOs and has no basis for assuming what any of them are like. It isn’t necessary or important to speculate on their personal qualities. The only thing the average person is entitled to assume is that the CEO has some minimal level of competence within his or her limited business sphere.
CEOs and Capital Allocation: An Economic View
Economists implicitly accept the common-sense view outlined above. They know that CEOs acted independently during the 30-year period referenced by William Galston. Collusion between many hundreds of CEOs is unthinkable. First, it would require acquiescence by company directors who have no obvious reason to go along with this dereliction of their fiduciary duty unless they were bribed. Second, every CEO would have an incentive to violate the collusive agreement if Galston’s scenario were correct. Third, there is no obvious means of making or enforcing such an agreement. These objections are decisive.
A few economists, such as Robert Higgs of the Independent Institute, have complained for years that investment spending has nosedived in recent years. Unlike Hillary Clinton, though, they do not identify a sudden upsurge in executive greed as the cause for this decline. Rather, the cause is the constellation of unfavorable external circumstances created by disastrous government policies.
Monetary expansion and artificially low interest rates. The average person has probably heard many times that the Federal Reserve lowers interest rates to encourage business borrowing, which stimulates production and income. If it were really this easy, we would never have recessions and unemployment, let alone Great Recessions or Depressions. There are various planted axioms underlying the simplistic Keynesian economics that gave rise to the myths behind easy money Fed policies. Most pertinent to our case are the assumptions that businesses would borrow because they anticipated producing additional output and selling all that they produce. If these assumptions don’t hold, then the low interest rates won’t have their anticipated effect.
In recent years, high unemployment has coexisted with high rates of job vacancy and low rates of labor-force participation. This has not encouraged business to believe that they can produce additional output if they borrow at the lower rates of interest. Shaky levels of consumer confidence have not encouraged business managers to think that they can sell additional output even if it is produced.
Perhaps most important of all has been the distinction between low interest rates as the natural outcome of a free market and low rates artificially contrived by the monetary authorities. The “Zero Interest Rate Policy (ZIRP)” maintained by the central bank in the U.S. and elsewhere does not allow the a priori savings desires of the public to equalize the investment demand of businesses at a free-market interest rate. Since there is no reason to think that actual interest rates reflect the true saving and investment desires of individuals, that means that businesses cannot draw any inferences about the future from existing interest rates. In a free market, interest rates are the informational link between the present and the future. When government severs that link, businesses cannot plan effectively. They cannot assume that the total supply of future goods produced will bear a reasonable relation to the volume of goods that people have been saving up to buy. This naturally makes business managers more cautious than they would otherwise be – no matter how low the nominal interest rate may be. If you can’t sell the output you’re producing with your brand new investment goods, it is little consolation that you got a great deal on the loan used to buy them.
Keynesian economists sometimes object that policies like Quantitative Easing affect only short-term interest rates, while investment spending typically involves a long term to maturity. But it is precisely this longer term that is most affected by the loss of interest rates as a planning tool. If we ever doubted it, our recent experience should have taught us once and for all that interest rates are comparatively trivial as a policy tool for government but they are invaluable as a planning tool for business.
Regulatory Costs and Uncertainty. The last 30 years have seen a steady procession of regulations and related costs. These costs have reduced investment by reducing the net earnings that finance it. In addition, the expectation of future regulation casts a pall over investment by increasing the probability of future cost increases.
When the Dodd-Frank bill was passed, it was advertised as a fail-safe measure designed to safety-wrap business against future failure in a crisis like the financial crisis of 2008-2009. Its costs and uncertainties of meaning and enforcement have proved so burdensome that they have pushed investment spending onto the back burner for the nation’s businesses. The regulatory present has pushed the business future into the deep shadows.
Bank regulation has made getting a loan so tough that the benefits of a lower interest rate have been more than counterbalanced. The derelictions of lenders during the real-estate bubble gave regulators such a black eye that they resolved to protect themselves in future by simply erring in the opposite direction of not approving loans, figuring that it will be much harder to blame them for this than for being too lax.
Mrs. Clinton’s assertions that she will, somehow, beneficially apply her seven-bracket capital-gains system to wring net benefits for us strains credulity. General reductions in capital-gains taxes have actually increased revenue in the past, but Mrs. Clinton’s plan calls forth memories of the wisecrack about the Clintons’ tenure in Arkansas. The Clintons believed in reducing taxes on business, so the joke went, “one business at a time, starting with their friends.” That is exactly the aroma wafting up from Hillary’s capital-gains brackets – the aroma of political favoritism.
Lack of Business Start-Ups and Entrepreneurship. The occasional technological success has somewhat obscured the generally dismal picture in business startups over the last decade. This is referred to explicitly by Holman Jenkins. This is another argument that strongly reinforces the common-sense conclusion reached above. If CEOs were able to able to work their will unhindered on shareholders and the general public, this would presumably have encouraged more people to start businesses. The fact that business startups have plummeted in the last 10 years suggests that external circumstances, not CEO misbehavior, are the root cause of the decline in business investment.
The Short Run and the Long Run. Mrs. Clinton takes it for granted that a focus on short-term profit is mutually exclusive with long-run performance. If by “performance,” she means “profit maximization” – and to an economist there is very little else that could be meant other than that – this is nonsense. By the terms of her own argument, Mrs. Clinton declares that long-run investment spending is necessary for growth and long-run “performance.” Precisely where could this long-run investment spending come from if not from short-run profits? After all, this is the debate – should short-run earnings be rebated back to shareholders via dividends or buybacks, or plowed back into the firm via investment?
Ironically, during the 1960s and 1970s, the political Left was excoriating CEOs and management for capital allocation, too. But in those days they were blaming management for shorting shareholders by reinvesting too much of the earnings and not returning enough in dividends! This was the outcome of a philosophy propounded in the 1930s by political scientist Adolf Berle and economist Gardiner Means in an extremely influential book warning that the modern corporation had created a “separation of ownership and control” that left management in the driver’s seat and the shareholders on the outside looking in. The board of directors was a rubber stamp for the CEO and the company was run for the benefit of management – and the proof was the overemphasis on investment and growth and the decline of dividend payouts!
Now, suddenly, the pendulum has shifted in the opposite direction. The only constant on the Left is that the corporation is bad and managers are the villains, although the reasoning now runs in the opposite direction.
In fact, there is no way that management can somehow ignore the long run and focus solely on the short run. The long run is a succession of short runs, so a constant focus on the short run cannot help but focus attention on the long run as well. The concept of discounted present value takes business revenue, cost and marginal revenue product of inputs and expresses their estimated future values in terms of a single present value by means of the practice of discounting. In this way, future values are telescoped back to the present day in value terms. The long run is united with the short run; the future is united with the present rather than being separated by the barrier of time. Markets automatically take account of the long run, whether we realize it or not – as long as interest rates and capital markets are allowed to work.
Viewing the situation as an economist, it is not hard to see why investment spending has slowed to a trickle. If we didn’t know better, we might easily suppose that the federal government had declared a “war on business investment spending.”
Short-Termism Weighed in the Balance
The economic case suggests that the arguments of Holman Jenkins are much closer to the mark than those of William Galston. It is true that one of Hillary’s shots from the hip found its mark; namely, her reference to CEO timing of events to maximize their own compensation. This certainly accords with the philosophy of self-interest, although the notion that shareholders are hurt by this practice is greatly overblown since it is not easy to show where the damage lies. But by the time we have finished shooting down the rest of Mrs. Clinton’s arguments, they are in shards.
As was demonstrated here, one need not be an economist or even know basic economics to recognize the fallacy at the heart of Mrs. Clinton’s contrived case against CEO short-termism. All that is required is a determined application of straightforward logic.