The Brookings Institution has released a report that I can only describe as “compelling.” Titled “More Builders and Fewer Traders,” it focuses like a laser on the perverse policy incentives that have contributed to dramatic levels of inequality.
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.
The report zeros in on four trends that have contributed to what the authors call “short-termism.” One consequence of these trends is that–while cash distributed to shareholders as a share of cash flow has surged– the share devoted to capital investment has fallen to a record low.
I don’t disagree with the authors’ focus on these trends, the problems they pose for the economy, or their contribution to inequality. I do wonder, however, how much of the lack of investment in the future of American industry can be traced back to the way we finance corporations and the separation of ownership from management.
“Ownership” can mean many things, but it is difficult to square our common-sense understanding of ownership with the purchase of a few hundred shares of stock in a major corporation. Such “ownership” carries with it no meaningful control, no right to make decisions, and “risk” only to the extent that there may be a decrease in the value of one’s stock.
The reality is that American corporations borrow money two ways–through the sale of bonds, which are more secure but which carry only a stated rate of return, and the sale of stock, the proceeds of which represent a gamble on the future of the enterprise: more risk, but the chance of a superior “reward.” Let’s be honest: Neither the bondholder nor the small or medium-sized shareholder is an owner in any meaningful sense of the word.
Meanwhile, the people managing these companies are frequently not “owners,” either. They’re hired hands, often with little investment in the business. Their compensation and continued employment depend significantly upon their ability to keep short-term stock prices high, thus they have every incentive to keep workers’ wages down and their own paychecks as high as possible.
None of this fosters the capitalist virtue of pride in the product, or good corporate citizenship (except as a marketing tool), or decision-making that is in the long-term best interests of the enterprise.
When a company is truly owned by an individual or small group, when those owners see their own prospects intimately bound up with the long-term success of the venture, corporate behavior changes. Such owners are certainly focused upon earnings and the bottom line–but they understand what innovations and behaviors will be needed to protect that bottom line into the future. Concern for long-term fiscal health provides incentives to care about their reputation, their workforce, the quality of their products and the health of the communities in which they operate.
When public policies incentivize short-term gains over long-term decision-making, the focus turns from producing goods and services to playing financial games–with broad negative consequences for job creation, wages, economic stability–and ultimately, American competitiveness.
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