Corporate America’s Focus On Short-Term Profits Is Hurting The Middle Class
It’s a familiar story: corporate profits are soaring while median household incomes remain stagnant. But corporate America’s excessive focus on short-term profits has also contributed to a slowdown in business investment. This lack of investment is not only a problem for shareholders, but it is also a problem for the middle class. In the long run, greater investment makes the economy more productive, which is essential for middle class growth. Reversing this trend of short-termism could increase investment, which could lead to more jobs, higher productivity growth, higher wages and greater innovation.
A new CAP report, released today, outlines recommendations to reverse this trend and, in turn, improve U.S. financial markets and encourage the private sector to focus on the big picture. The report lays out the economic theory that explains how markets can come to be excessively focused on short-term profits rather than investing in things like innovation that would add long-term value to corporations. Furthermore, it identifies anemic business investment growth as a direct aftereffect of the trend toward short-termism. The graph below shows the slowdown in business investment.
CAP’s report also looks at evidence of short-term thinking among publicly traded firms and identities three important players in the growth of short-termism: managers, short-term traders, and institutional investors. Finally, the report proposes a series of policy recommendations—for both managers and investors—that could help nudge financial markets toward a focus on the long term, benefitting managers, shareholders, and the middle class. Those recommendations include:
For managers:
- Change the executive compensation provision: Congress should tweak the provision making performance compensation more than $1 million tax deductible in ways that motivate CEOs to focus on the long term, such as requiring that equity compensation take longer to vest.
- Enforce existing insider trading laws: Insider trading erodes public confidence in markets, and reduces incentives for companies to make long-term investments. Greater efforts to both enforce existing laws and publicize enforcement actions would require no action from Congress, reduce the influence of asymmetric information, and improve the incentives for managers to make productive investments.
- Require more frequent and comprehensive reporting on share buybacks: There is currently no detailed longer-term reporting on how share buybacks occur, which makes it hard for investors to know if firms are buying shares in a way that transfers money from shareholders to management. Making this process more transparent with SEC requirements would make buybacks a better deal for shareholders and less susceptible to insider manipulation.
For investors:
- Support a sliding capital gains tax: Currently, the tax code currently rewards investors by giving investors a lower tax rate on investments held for more than a year. But one year is not nearly long enough, a sliding capital gains tax that falls the longer an asset is held would create a larger incentive for long-term investments.
- The SEC should require the disclosure of pay slices: Large pay slices—the share of compensation among the top five executes paid to the CEO—are associated with worse performance for the CEO. Pay slices can also be an indicator of excess compensation, so the SEC should consider requiring its prominent disclosure.
- Take steps to empower long-term investors: Because executives’ incentives are currently focused so strongly on the short term, companies should take affirmative steps to empower longer-term investors.
BOTTOM LINE: With corporate profits soaring but increasingly decoupled from investment and income stagnant, focusing on the big picture is more important than ever for American markets. Shifting corporate America’s focus away from short-term profits and toward investing in things like innovation will increase long-term value, benefitting shareholders and the middle-class alike.
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