Looking for the Economy-Wide Effects of Stock Market Short-Termism

Mark J. Roe is David Berg Professor of Business Law at Harvard Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here);  Don’t Let the Short-Termism Bogeyman Scare You by Lucian Bebchuk (discussed on the Forum here);  Will Loyalty Shares Do Much for Corporate Short-Termism? by Mark J. Roe and Federico Cenzi Venezze (discussed on the Forum here); Stock Market Short-Termism’s Impact by Mark J. Roe (discussed on the Forum here); and Corporate Short-Termism – In the Boardroom and in the Courtroom by Mark J. Roe (discussed on the Forum here).

To investigate the widespread claim that stock market short-termism is a major drag on U.S. corporate investment, R&D, and the broad economy, I review for this paper in the Journal of Applied Corporate Finance trends in corporate capital investment, stock buybacks, and R&D that stretch back, in some cases, over the past 50 years. (I also briefly summarize firm-level data—which I analyze more extensively elsewhere—and explain limits in extrapolating strong policy recommendations from firm-level data.)

As critics of market-driven corporate short-termism have pointed out, U.S. corporate investment in capital equipment and other tangible assets has been falling steadily since the late 1970s, and buybacks have been rising, while stock market short-termism is thought to punish corporate R&D spending. This relationship is suggestive of large public firms pushing out their cash and weakening their capacity to invest, while forgoing their future by weakening R&D work. If the story of economy-wide short-termist decline due to increasing stock market pressure for immediate results were valid and strong, we would expect to see the following: (1) investment spending in the United States declining faster than in Europe and Japan, where large companies depend less on stock markets for capital and where shareholder activists are less influential; (2) cash from large share buybacks inducing a bleeding out of cash from the U.S. corporate sector; and (3) economy-wide declines in corporate R&D spending.

However, U.S. corporate R&D spending has been rising since the 1970, and has been rising faster than the economy is growing. And while corporate distributions of capital through dividends and gross buybacks have also been rising sharply for decades, corporate cash holdings (as a percentage of total assets), have reached near record high levels. The best explanation for such high cash holdings together with record-high payouts is the striking match between the size of such distributions and new corporate borrowings. Moreover, the annual pattern of net payouts by S&P 500 companies, often mature companies, is remarkably similar in size to net new investment into smaller public companies outside of the S&P 500 companies.

Capital spending by European and Japanese companies, situated in financial markets where stock markets are less influential than they are in the U.S., has been falling more rapidly than that of American companies. That fall suggests that U.S. stock-oriented capital markets may not be a particularly powerful source of corporate shortsightedness and alternative explanations for the decline in spending on hard assets are in play.

True, none of these trends in capital investment, R&D, and buybacks precludes the possibility that had the critics’ proposals to reduce stock-market-induced short-termism been in place decades ago, investment, R&D, and overall performance would have been even better. But before embarking on expensive reforms, we should have more confidence that there is a severe problem that needs addressing. Yet neither the economy-wide data, analyzed here, nor the firm-level data, analyzed elsewhere, set a strong foundation for extensive policy recommendations. Moreover, thinking so may lead policymakers to miss better targets for improving the underlying problem. For example, while critics see short-termism as damaging American R&D, the numbers show corporate R&D spending to be rising, while government support for innovation and R&D has been falling since the financial crisis. If innovation needs more support, it’s the government cutbacks that would first seem to need to be addressed.

The complete paper is available for download here.

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