How American businessmen are ruining American business — and the U.S. economy

Corporate America must get out of its short-term mindset

(Image credit: (Chris Hondros/Getty Images))

For nearly 50 years, Gallup has been asking Americans if "big government," "big business," or "big labor" is the greatest threat to the United States in the future. And never have more of us been more cynical about politicians and federal bureaucrats, with 72 percent of polled Americans picking big government, 21 percent big business, and 5 percent big labor. We worry much more about Washington screwing up America than we do Apple, Exxon Mobil, or Walmart taking us down.

Those results are hardly surprising, what with fear about rocketing federal debt, the ballooning costs of Social Security and Medicare, the growing surveillance state, and continuing unease about the expansion of government tied up in Obama's health-care reform. But don't give business a pass. Americans are greatly underestimating the damage that the suits in the C-suite and their short-term thinking are inflicting upon the U.S. economy.

The missing link in the anemic, five-year-old recovery has been business investment. And big business itself deserves a lot of the blame for that. Instead of using record profits to buy new equipment or build factories — and boost the economy — corporate America has been sitting on nearly $2 trillion in cash. Corporate balance sheets are stuffed.

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When CEOs do put money to work, it's almost always to help shareholders, through higher dividends and stock buy-backs that boost share prices. More recently, companies have been using some of that dough for a tricky financial technique known as an "inversion," buying an overseas rival to take advantage of lower international tax rates. Never have companies spent such a tiny share of the cash they generate on capital investment, according to economist Andrew Smithers.

Even worse, argues Harvard's Clayton Christensen in a recent paper, much of that investment is directed toward making existing products or delivering existing services more efficiently — often with fewer workers — rather than innovating new products or services that create new, high-paying jobs. This plague of risk-averse "short-termism," as Nobel-winning economist Edmund Phelps writes in Mass Flourishing, reduces the total "supply of innovation" in the U.S. economy, resulting in slower growth and job creation.

On the surface, of course, none of this behavior makes much sense. Why would smart businessmen act so myopically? With coffers full and borrowing easy thanks to low interest rates, why wouldn't a company spend big to either expand today or invest in long-term projects with a large potential payoff tomorrow?

First, executives pay has become more dependent on bonuses, often linked to a company's stock prices — rather than salaries. At the same time, CEO tenure has declined since 2000. So bosses have big incentive to embrace short-term strategies — like buy-backs — that keep the stock price high and avoid those — like, say, a pricey new research initiative — which might make it tougher to hit those all-important quarterly earnings targets. As a result, Smithers writes in The Road to Recovery, "managements are willing to accept possible long-run damage from lower investment and the possible loss of market share." That's the next CEO's problem.

Second, executives have been slow adjust to a world where capital and cash are abundant. No longer, Christensen explains, do they have to worry about squeezing every bit of revenue and profit out of each dollar deployed ASAP. But that's the strategy they were taught in business school decades ago, so they keep right on doing it.

Third, investors, even those supposedly in it for the long run, like pension funds, aren't doing their job. They're not nudging management to lift their heads and look to the horizon. Instead, shareholders threaten to dump a company's stock if they miss those earnings targets, which Phelps compares to paying ransom to kidnappers.

Dealing with short-termism may be a long-term project. Executive pay will need to sync more closely with what's good for the overall economy, such as being linked to increased investment. Some research suggests limiting or eliminating "golden parachute" paydays for departing CEOs. Business school curricula will have to change. And Phelps says fund managers shouldn't be allowed to threaten company officials with financial damage if they miss earning targets.

And hey, maybe if business starts thinking more about the long term, maybe government will, too.

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