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The long and short of it.

What exactly does drive Corporate America's investment decisionmaking, and how can its time horizons be extended?

Short termism has become a widely accepted explanation of America's longterm economic difficulties. It was one of the charges the Japanese leveled at American industry in the wake of President Bush's December 1991 trip to Japan. In the early days of the Bush administration, Richard Darman, Director of the Office of Management and Budget, described an America that "wanted its Maypo and wanted it now." One commentator saw short termism at the heart of the Go-go 1980s that stood in sharp contrast to an earlier America that built rising prosperity on a steady stream of coal.

Is it true? Has America traded the almighty dollar for the quick buck? America's recent inclination to short termism has been widely accepted, but its magnitude had been left unmeasured and its causes largely unexplained.

The council of Competitiveness, a private sector coalition of leaders from industry, academia, and organized labor, joined with the Harvard Business School to take a detailed look at the question of short termism. The research team was lead by Michael Porter, Harvard Business School professor, widely quoted author, and Council executive committee member. A group of top business school representatives and economics analyst explored a broad range of topics; in an attempt to gauge the dimensions and causes of short termism. Much of the work has been funded by the Alfred P. Sloan Foundation.

We started with the idea that short termism was a real problem. But we realized that a variety of public and private initiatives did not fit into a picture of a society condemned to a culture of endless todays and to corporations unable to see beyond the next quarter's financial statement.

Americans may want they Maypo, but we have just spent trillions of dollars over four and half decades to win the Cold War. By any measure, America still leads the world in basic science - the kind of largely public investment that pays dividends over the very long term. The story is equally complex in industry. We lead the world in aerospace and are very competitive in pharmaceuticals, two industries that demand a long-term perspective. Our venture capital industry makes high-risk investments that may take years to pay off. The team suspected that privately held firms may behave differently in terms of time horizons orientation than those that are publicly traded. And there may be other exceptions as well in American industry to the preoccupation with the short term.

These exceptions; did not mean there was no short-term rule. Michael Porter is still pulling together the strands of research into an overall explanation of how the American pattern of capital allocation affects the quantity and composition of corporate investment, but the research already point to several clear findings.

The Slowing Pace of American Investment. In terms of plant and equipment investment as a percentage of GDP, America has trailed the other major industrial democracies for much of the last 20 years. In terms of simple exchange rate, Japan, with an economy roughly half our size, has actually put more dollars that the United States into new plant and equipment over the last three years. Our investment in infrastructure relative to GNP is roughly half what it was in the early 1960s.

Research and development remains an American strength, but even here we lag behind Germany and Japan in the proportion of national income devoted to non-defense R&D. We do invest in education, although much of that is public investment and the results are mixed. America still sets the world standard for research universities, but the academic quality of K-12 education varies widely and, on average, does not match the best in terms of math or science.

The influence of Macro Economics. The national economic environment can push Corporate America toward shorter-term investments, or pull it toward a long-term perspective. In the 1980s, the ups and downs of exchange, interest, and growth rates all contributed to an unpredictability that increased uncertainty and decreased investment.

Although not part of our project's research agenda, other work points to the importance of complimentary public investments in everything from roads to research.

In an era of strategic trade, an indifferent trade policy can reduce export opportunities or expose domestic industries to the international strategies of our major competitors. And the result will also be reflected in the quantity and direction of corporate investment.

The Cost of Capital. A higher cost of American capital is an explanation of short termism that attracts most economist. The higher the cost of capital, the quicker an investment must pay off. However, an examination of the economic and business literature raised questions about how much capital cost had varied. And, as national capital market become more closely integrated, the costs of largely riskless debt should converge.

Risk may be the key word. The arm's-length, often adversarial relationship between American capital providers and corporate investors leads to a generally higher level of capital records.

The Investment Priorities of Management. In the 1960s, American business developed a view that quality management was virtually as fungible as money: If you could run a bakery, you could run a bomb factory. After all, it was the financial statement that mattered.

The philosophy distanced top management from the actual nature of the investment and led to a pattern of underspending on investment that were not so easily evaluated from the distance of corporate headquarter - investment in training, research, information systems, or export markets.

The Goals of Corporation.In the United States, the goals of the corporation were largely focused on the market value of the corporation or the total returns to the shareholder. In Germany and Japan, the interest of employers and the stakeholders weigh more heavily in the corporate calculus. Where exit from an investment is often seen as a viable American option, perpetuity of ownership was more likely to be the German or Japanese goal.

The Anglo-American System vs. Deutsche Bank and Keiretsu Capitalism. As the researchers looked at the U.S., Germany, and Japan, three distinct types of capitalism emerged. In the U.S., ownership was sharply divided from the actual operation of the corporation, and financial investing was one of a series of transactions or was frequently focused on anticipating specific events, such as a research breakthrough or regulator decision. In Germany and Japan, investors had an active involvement with the corporation. Investments often led to long-term relationships rather than short-term transactions.
Institutional Ownership of U.S. Financial Assets
 Total Total
 Outstanding Owned by Percentage
 Assets Institutions Owned by
 ($ bil) ($ bil) Institutions
1950 $1,280.9 $107.0 8.4%
1955 1,798.4 170.1 9.5%
1960 2,366.9 255.7 10.8%
1965 3,401.3 391.7 11.5%
1970 4,639.5 568.9 12.3%
1975 7,096.5 913.6 12.9%
1980 13,110.2 1,769.0 13.5%
1985 21,330.8 3,297.6 15.5%
1990 31,801.2 6,520.4 20.5%
Sources: Federal Reserve, Columbia Institutional Project, and New York Stock Exc

Not too long ago, the U.S. saw the world in stark, binary, almost Manichaean terms. There was democratic capitalism and totalitarian central planning. The end of the Cold War has forced us to look more closely at the varieties of capitalism that have spread across Europe and East Asia.

We as nation are beginning to look seriously at lessons from abroad. Some innovations are already rippling through American corporations, as they adopt the total quality approach, build closer relations with their suppliers and workers, and form ad hoc alliances to make the most of America's innovative strength. More American officials are looking to European and East Asian approaches for ideas on education and training. In a very real sense, we are discovering that a national commitment to community and country will lead to greater long-term competitiveness.

But I am getting ahead of the Council's story. At this writing, the Time Horizons Project team is completing its report for release in the spring. Our hope is that the full report will stimulate the new round of thoughtful analysis on the long-term vs. short-term conundrum that affects the decisionmaking of American board members and senior management. The issues discussed above in this preliminary preview of the report clearly lead us to believe that our business leaders's line of sight - and accompanying management practices - must extend t a farther horizon if the U.S. is to emerge with its vitality intact at the end of this decade.
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Title Annotation:Chairman's Agenda: Governing for Shareholder Prosperity; investment decision making
Author:Hughes, Kent
Publication:Directors & Boards
Date:Mar 22, 1992
Previous Article:The challenge of governing for value.
Next Article:The high cost of confrontation.

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