It’s curious that despite robust bottom lines, a recovering global economy and the support of central bankers, corporate America recently has grown more cautious about putting those earnings to productive long-term use.
The issue is of more than academic importance. According to the Federal Reserve Bank of Cleveland: “[Business] investment today is strongly, positively correlated with GDP in the future. More than just expanding GDP in the future, growth in the capital stock through investment puts upward force on wages by making workers more productive.”
Recent data compiled by the Cleveland Fed show that private fixed investment as a percentage of GDP is 13%, significantly below its long-run average of 15.3%. Though a meaningful amount of that shortfall is housing-related, nonresidential private fixed investment (a proxy for corporate capital spending) has fallen to 4.3%, less than half the level reached in the aftermath of the Great Recession.
A new working paper by John Asker and Alexander Ljungqvist of New York University and Joan Farre-Mensa of the Harvard Business School suggests one possible explanation. The professors detected a striking difference in the capital spending patterns of public and private firms. They postulate that Wall Street’s hypersensitivity to the latest quarterly earnings report might be a reason.
As executive compensation packages over the last quarter-century have become increasingly linked to stock-market performance, the study asserts that a “short-termism” has infected the mindset of some key decision makers. Spending on new plant or equipment that would boost productivity in the future could cause an earnings miss and thus risk a sell-off in the company’s stock.
Given the clear historical link between productivity and living standards — and on a company-specific level, often to stock-market performance as well — the report should serve as a reminder to corporate boards and CEOs of the need to align their firm’s future with those of its long-term shareholders.