“It’s pretty simple, there is too much “short-termism” and financial gimmicks (lack of investing for the future, excessive leverage, share buybacks, etc.) in the public capital markets and it is hurting employment and the economy. That’s why Dell went private. The SEC needs to step up and change the voting rules. If you haven’t owned a company’s shares for say three years, you can’t vote them…

…Only long-term shareholders (or those who have acquired a majority stake, not a majority of short-term shareholders) should be able to vote. Issue solved.” Mike Perry, former Chairman and CEO, IndyMac Bank

Politics & Ideas

‘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

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.

Posted on December 10, 2014, in Postings. Bookmark the permalink. Leave a comment.

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