A major puzzle in the current economic scene is the absence of business investment.
Corporate profits relative to the GDP have reached record levels. There has been a slight gain in corporate investment since the recession ended, yet capital spending is hovering around the lows of earlier cycles. What is the explanation? The answer is short-termism.
Rather than spending some of the huge corporate cash reserves, business is returning cash to shareholders, usually in the form of share buy-backs, a trend that is proceeding way above the historical rate.
In previous cycles companies invested as much as they returned to shareholders. Nowadays, management incentives have altered the usual pattern.
Corporate chief executives are rewarded in the form of bonuses rather than in straight salaries, although the latter have risen astronomically. These bonuses frequently are tied to share prices and are related to the ability of the company to meet its quarterly share “guidance”, the numbers that are released to the general public.
Hence, corporations now are likely to have a program of share buy-backs. That means that there then are fewer shares outstanding, so profits as published are spread over a diminished number of shares outstanding.
As a consequence earnings share as reported rise whereas investment programs more than likely would reduce that number for some time.
What has happened is predictable. Bonuses to management that are related to corporate/share performance were less than would be the case if investment in expansion or amalgamation were to occur.
Heretofore management was foregoing longer-term risk that would be entailed in investment, and rather emphasized maintaining profit margins and was unwilling to take a longer-term perspective that would mean better performance eventually.
A recent study revealed that management would not go ahead with a possible long-term project that would be profitable, but instead would opt for a short-term move that would enhance corporate per share performance immediately.
Therefore, investment opportunities are ignored because of the short-term goals of management. Management looks only to meeting earnings projections in order to ensure that bonuses will be paid.
This selfish attitude says a great deal about the ethics and goals of so many corporate chief executives – a long-term bias that is shameful.
It is no surprise then that the financial industry is regarded with such disdain.
Tax regulations should change to eliminate these tactics.