This has been a remarkable year for the markets. The S&P and the Dow indexes are up 18% and 19%, respectively. But this run-up isn’t based on solid business foundations. Quarterly profits have only increased 5% since 2012, but investors’ valuations of those profits (as measured by earnings per share) has increased 59% over the same period. What’s behind the disconnect? Some argue that profits are stagnant because of short-termism—that decades of focusing on current profits over long-run innovativeness has resulted, now, in companies that are hollowed out.
The Real Reasons Companies Are So Focused on the Short Term
Most attempts to combat short-termism are flawed because they focus on changing CEO behavior through some combination of pleading and incentives. While well-intentioned, these efforts fail to recognize that CEO behavior is largely circumscribed by firm structure. In particular, there are three widespread, interrelated structural trends that have fostered short-termism and reduced corporate innovativeness: increased hiring of outside CEOs (particularly from the late 1980s through the 2008 recession); the decentralization of R&D (over a similar time frame); and a focus on the “development” side of R&D rather than the “research” side. Reversing these trends would allow companies to invest for the long term, increase their innovativeness, and grow the economy.