Boosting America’s Competitiveness : Investment Pressures for Short-Term Gains Must Be Changed

Not long ago a well-informed executive listened to still another discourse on the damage that short-term managerial thinking is doing to the U.S. economy and its ability to continue generating jobs and decent living standards for Americans.

“I think we all know by this time what the problem is,” he commented. “What we should be talking about now are solutions.”

The new Democratic-controlled Congress is acutely aware of growing concern over the huge trade deficit and what it says about the American economy’s seeming inability to compete with foreign producers, either at home or abroad.

There is a built-in temptation toward protectionist legislation limiting foreign access to the U.S. market. But both the Reagan Administration and responsible Democratic leaders believe that such an approach would do more harm than good. So the buzzword in Washington these days is competitiveness.

It remains to be seen, though, whether elected officials are ready to do what’s necessary to deal with one of the major sources of this country’s eroding ability to compete: the short-term focus of many U.S. business executives.

As Congress and the Administration cast about for concrete means of making America more competitive, the ideas propounded by Pat Choate, a Washington-based corporate economist with strong ties to influential people in government, are getting a lot of attention. Most of his proposed correctives make sense.

In “The High-Flex Society” (Knopf, 1986), co-authored with J. K. Linger, Choate allies himself with those who, while bemoaning the barriers facing U.S. exporters in Japan and many other foreign markets, are convinced that America’s lack of competitiveness is to a major extent self-inflicted.

Choate has a number of interesting proposals for reform of the antitrust, copyright and patent laws, tax incentives for research and development, retraining of displaced workers, financial help for small business and timely penalties against foreign exporters and governments that won’t abandon unfair trade practices.

But the TRW economist’s most intriguing contributions are his proposals for dealing with the short-term thinking that prevails in corporate America these days.

There is widespread agreement that a major culprit is the power wielded by institutional investors, especially pension funds, which demand high quarterly earnings with little or no regard for a company’s long-term competitiveness and profitability. Companies that don’t pay attention find their stock dumped by the funds or, worse, find themselves the targets of unfriendly takeovers by raiders who promise stockholders an immediate profit.

Choate observes that institutional investors now hold more than 35% of all equities listed on the New York Stock Exchange, double their share in 1960, and the figure is still going up.

The harmful effect is suggested by the findings of a 1985 survey of 308 large institutional investors; only 4% reported that the quality of a company’s products, normally a sound gauge of its long-term competitiveness, was a factor in their selection of stocks for investment.

The speculative bent of the big funds is further reflected in the constant churning of their stock holdings. They turn over 40% to 50% of their portfolios each year, compared with a turnover rate of 10% to 15% for individual investors.

In their compulsion to produce short-term results that will please fund managers and help to fend off takeover attempts, many companies are crimping their future ability to compete--even to survive--against Japanese and European producers who think in long-range terms.

In both 1984 and 1985, U.S. firms spent more than $100 billion to finance buybacks of their own stock. To quote Choate, “If these funds had been used to modernize plant and equipment, total capital investment would have been 25% higher.”

Anti-takeover strategies have included the abandonment or avoidance of product areas that might pay off in the long run but are unprofitable in the short term, and shying away from heavy spending to develop new markets.

As Ruben F. Mettler, chief executive of TRW Inc., told the Wall Street Journal the other day, another sure yet deplorable way to “pump up earnings very dramatically is to cut research and development spending.” Many firms are doing it.

The challenge is to change the decision-making environment in which business operates.

Choate’s most sensible-sounding proposal is the imposition of a sliding-scale tax on short-term gains from stock trades by pension funds. The longer a stock was held, the lower the tax would be until, at some point, it would be zero. This approach would penalize short-term speculation while rewarding funds that emphasized long-term investment.

Choate also observes that the present compensation system for fund managers has the effect of rewarding them for rapid stock turnovers. He proposes that federal regulations be modified to require that compensation be tied in some way to the long-term performance of the funds that they manage.

(Business consultant Peter F. Drucker noted recently that managers of corporate pension funds are often under unhealthy pressure themselves from the companies involved to produce immediate gains so that the firms’ pension-fund contributions that year can be reduced and their reported profits enhanced. The answer here obviously lies in legislation making clear that the primary fiduciary responsibility of pension-fund managers is to the workers whose retirement money is involved, not to the companies that have already taken tax write-offs for pension contributions.)

Reform won’t come easily. Too many stockbrokers and fund managers have become accustomed to the big fees generated by the rapid turnover in stocks; simple greed will lead them to oppose corrective measures. Corporate managers will resist any plugging of the loopholes that now allow them to raid pension funds for their own purposes.

In short, the challenge that is facing the Democratic-run Congress is to prove that the expansive talk about enhancing U.S. competitiveness is not just a lot of hot air.