WALL STREET JOURNAL

OPINION (Published December 10, 2014, page A16)

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LETTERS

Federal Government Policies Encourage Short-Termism

Never before has the incentive been so stark to make short-term business decisions at the expense of the long term.

Wall Street Journal Dec. 1, 2014

That “‘Shareholder Value’ Is Hurting Workers” (Politics & Ideas, Dec. 10) there should be no doubt, as William Galston writes. To any rational observer, the abundant money showered on the world by the Federal Reserve at near-zero interest rates is too appealing to private equity and hedge-fund operators. They easily borrow massive amounts of it and buy some or all of the equity in companies, and force the directors and managements to do what they think right for short-term payoffs. Included is slashing employment for “efficiency”—hurting workers but bringing greater profits. Some of those additional profits are used to pay fees and expenses of the new investor/owners and make dividend distributions or buy back outstanding company stock. That money paid or “returned” to the investment funds creates billions of dollars of performance fees for the partners of the investment funds.

The outlooks of the companies become shorter and shorter as the fund managers seek more of those performance fees for their own enrichment. While company managers and directors must always balance the long term against the short term, never before has the incentive been so stark to make short-term decisions at the expense of the long term.

The ultimate enabler of this practice is the government. If it really wanted corporations to make longer-term decisions—hiring and training more employees for the future—it would raise interest rates, rein in the money supply and tax the incentive compensation for private-equity managers at ordinary rates. Also long-term capital gains should be taxed according to holding periods, with a lower tax the longer the holding period.

Theodore M. Wight

Seattle

The piece that this Letter was discussing:

‘Shareholder Value’ Is Hurting Workers

Financiers fixated on the short-term are forcing CEOs into decisions that are bad for the country.

By 

WILLIAM A. GALSTON

Dec. 10, 2014

Buried in the positive employment report for last month was a small fact that points to a larger reality: Between November 2013 and November 2014, the U.S. labor force grew by 0.7%. If that strikes you as a small number, you’re right. According to the Bureau of Labor Statistics, the labor force grew annually by 1.7% during the 1960s, 2.6% during the 1970s, 1.6% during the 1980s and 1.2% during the 1990s, before slowing to 0.7% during the first decade of the 21st century. Between now and 2022, the rate of increase is expected to slow still further, to only 0.5% annually.

The surge of women into the paid labor force peaked in the late 1990s, and baby boomers—all of whom were in their prime working years in 2000—are leaving the labor force in droves. Youthful immigrants are replenishing the workforce from below, but not nearly fast enough to counterbalance the aging of the native-born population.

When Bill Clinton left office, every baby boomer was in what is considered to be the prime working-age category, between 25 and 54. By the end of 2018, none of them will be. By 2021, more than half of the boomers will be over age 65, participating in Medicare and—in most cases—Social Security.

In 1992, 100 workers supported 92 nonworkers—mainly the young, the elderly and those with disabilities. By 2012, 100 workers were supporting 102 nonworkers, a number that is projected to rise to 107 by 2022.

These dry statistics have real-world consequences. For example, just about everyone believes that we need to accelerate the pace of economic growth and sustain that higher level. This is harder to do when the expansion of the labor force—a major source of economic growth—slows to a crawl. It means that during the next decade, growth will depend more on increased capital investment, faster technological innovation and improvements in the quality of the workforce, than during the past generation. And that means that firms will have to change the way they think.

Few investments will produce high returns as fast as shareholders (especially activist investors) have come to demand. That is why businesses are hoarding so much capital—and using a record-high share of their earnings to buy back their own stock. And businesses have become more reluctant to invest in training their rank-and-file workers, in part out of fear that valuable workers will move and take their human capital with them, and in part in the belief that workforce training is the responsibility of the education system.

An article by Nelson Schwartz in the Dec. 7 New York Times offers a vivid example of what is driving current business behavior. In the name of “unlocking value,” Relational Investors, a firm that manages pension funds, forced the Timken Corp. to split into two firms, one making steel, the other bearings. In the aftermath, the new bearing company slashed its pension-fund contributions to near zero and cut capital investment in half, while quadrupling the share of cash flow dedicated to share buybacks. In place of an integrated, low-debt firm whose stable but less-profitable bearing lines could help cushion swings in the more-profitable but more-volatile steel business, the split left two firms that will be pressured to assume as much as $1 billion in new debt.

High leverage may make sense in some sectors, but not in industries whose competitiveness depends on large investments and longtime horizons. Timken survived the deep recession of the 1980s, which drove many American manufacturers out of business, only because it made massive investments in state-of-the-art production facilities that meant, says Mr. Schwartz, “lower profits in the short term and less capital to return to shareholders.” Because of this patient approach, Timken was able to dominate the global market in specialized steel while providing good wages to workers and contributing to schools and public institutions in its hometown of Canton, Ohio.

It is often argued that managements, such as Timken’s once was, are violating their fiduciary responsibility to “maximize shareholder value.” But Washington Post economics writer Steven Pearlstein argues that there is no such duty, and UCLA law professor Stephen Bainbridge, past chairman of the Federalist Society’s corporate-group executive committee, backs him up. In practice, Mr. Bainbridge has written, courts “generally will not substitute their judgment for that of the board of directors [and] directors who consider nonshareholder interests in making corporate decisions . . . will be insulated from liability.”

The Timken episode has nothing to do with legal fiduciary responsibility. It is a microcosm of the struggle between a financial sector fixated on short-term returns and corporate managements who are trying to run profitable businesses while sharing some of the gains with their workers and communities.

If we continue down this road, we won’t have the long-term investments in workers and innovation that we need to sustain a higher rate of growth. And that would be bad news for the country.