Criticisms of Short-Termism in Corporate Spending Misplaced

A law professor at Harvard University set out to investigate the claims that companies practice “short-termism” by seeking favorable outcomes in the present at the expense of the future.

The media and politicians often claim that companies practice “short-termism” by seeking favorable outcomes in the present at the expense of the future. Calls for corporate policy reform spring from the belief that corporations are mainly driven by immediate returns and shareholder value instead of being focused on research & development (R&D) and reinvestment that could benefit the economy in the long term.

Mark Roe, a law professor at Harvard University, set out to investigate these claims. If capital allocation decisions are being made solely to maximize the short-term benefits, three events should be occurring: U.S. investment spending should decline faster than in Europe and Japan, cash levels should be falling among corporations due to spending on buybacks and an economy-wide decline in R&D spending should be occurring. Roe found none of these to be the case.

Total R&D spending in the U.S. as a proportion of gross domestic product (GDP) has been rising, not falling. Since the 1970s, it has doubled. When expenditure declines do occur, they are cyclical in nature and follow the overarching trend of the markets, most recently seen during the 2008 financial crisis and 2020 pandemic.

R&D Spending in the U.S. Rising as a Proportion of GDP, 1977–2019

While stock buybacks have been increasing, so have corporate cash holdings (as a percentage of total assets). “During the past decade, the total cash held by (non-financial) S&P 500 companies has actually been rising. In 2019, the S&P 500 collectively held about $75 of cash for each $1000 of GDP, up from $50 in 2009 and $25 in 1980,” notes Roe.

One reason why cash balances have increased even as spending on buybacks has grown is debt. Following the financial crisis, corporations have taken advantage of low interest rates to finance their share repurchases.

Furthermore, some of the money spent on buybacks has been reinvested into smaller (non-S&P 500) companies. In fact, the total inflow of capital into these companies exceeds the total outflow from the larger S&P 500 companies.

Source: “Looking for the Economy-Wide Effects of Stock Market Short-Termism,” by Mark J. Roe; SSRN, December 2021.