Mark J. Roe
Says More…

Mark J. Roe: Yes, there are. First, though, we should make sure that we see clearly why efforts to reverse climate change by tackling stock-market short-termism are misguided. As I noted in my June piece for PS, when we drive our cars to work – rather than, say, walking, biking, or taking public transportation – we are not deferring the personal costs of those emissions. Rather, we know that we will not ultimately pay much at all for our own emissions. Our contribution to global warming is thus not arising from a time-horizon problem.

The same goes for companies. They emit too much carbon dioxide – or sell too much that emits carbon – because it is profitable to do so, as they will bear only some of the short- and long-terms cost of those emissions. It is a question of who pays, not when. Most companies will never pay up for their own emissions, or for climate damage from their products. So, tinkering with corporate time horizons will do little good. Instead, we have to make sure that the emitter/polluter is also the payer. Remedies like carbon taxes achieve this, thereby better aligning corporations’ (and car-drivers’) incentives with the social good.

As for other straightforward interventions, a good example relates to research and development. Those who blame short-termism for purportedly falling R&D spending argue that firms are foregoing it because the costs for R&D are immediate but the benefits are not. The stock market demands profits now, the critics’ logic goes, so such future-oriented R&D spending must be a no-go.

Yet convincing studies show that shareholder activism leads to better, more effective R&D, as I discuss in my analysis of stock markets, activists, and short-termism in Part II of Missing the Target. Moreover, corporate spending on R&D is rising faster than the economy is growing. Maybe it should be rising even faster, but there is little evidence to support the perception that the stock market’s aggressiveness has been killing R&D in recent years.

What is indisputable, however, is that in the United States, government support for R&D has declined in recent years, while it has risen in Germany, Japan, and China. But public support in for R&D has been a significant source of economic advancement in the US. If we slash that spending, the possibilities of success decline greatly. And herein lies the straightforward intervention.

On this front, recent legislative developments – for example, the just-passed CHIPS and Science Act – are encouraging. I wouldn’t defend every aspect of recent legislation. But if we are worried about falling behind in microchip technology and that this is causing the entire US economy to suffer, then in boosting public investment in R&D, Congress is moving in the right direction.

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MJR: A key justification for public pressure on corporations to lead the way in reducing emissions has been that the US government is too broken to act. Putting the responsibility on corporations was always viewed as an imperfect solution, even by most proponents. But for many, it seemed like the only viable option.

For the reasons I highlighted above, this approach has had little impact on large publicly traded corporations’ contribution to climate change. We should not expect open-ended pressure to amount to a strong, stable solution. And whatever effect it might have could readily be offset by privately held companies that are not subject to the same public pressure. They would simply take over – and reap major profits from – climate-degrading activities.

With the Inflation Reduction Act, government is proving that it has not become permanently inert. It may not be perfectly devised, but what policy is? It may not be enough – especially without adequate international coordination – and it may not last. Some of the effort to incentivize abatement may not work as well as we want it to work. But the bill became law and that does challenge the logic that has driven so many people to support a “solution” to climate change that will never work – namely, fighting stock-market short-termism.

MJR: Stock buybacks are often scorned as peak short-termism. In buying back their stock, the logic goes, companies are trying to satiate Wall Street’s hunger for cash now, even if it means being left without funds for R&D and other investments. This narrative has taken hold not only among the public, but also in many policymaking circles. But it is wrong.

Corporate America is not starved for cash. On the contrary, corporations are getting so much cash by other means – from borrowing, from profits, and from selling stock – that corporate cash is increasing, even as buybacks rise. R&D spending is also rising, even as buybacks rise. So, buybacks are not draining corporate cash or killing investment and R&D. To some extent, they might even be helping: buybacks help get cash from firms with weak investment opportunities to firms with strong opportunities.

Is the new tax on buybacks a bad thing? It’s small enough that it probably won’t have much of an impact, making it hard to criticize. Yes, it could establish the foundation for higher taxes later. But even then, it probably wouldn’t matter much, as companies with extra cash but without good investment opportunities can still move the cash out by paying dividends, though buybacks are sometimes a more convenient way to achieve this.

To be sure, there are legitimate criticisms of buyback rules – namely, that they may allow executives to use buybacks to pump up their stock options’ value, depending on how their stock-options terms are set up. That problem is worth addressing, but it’s not a convincing reason to stop buybacks altogether.

As for the corporate-tax reforms that would do the most good, one stands out: address the structural problem to which you refer in your question, by reforming the deductibility of interest from corporate tax bills. It’s not an issue that gets the same public attention as stock buybacks or stock-market short-termism, but it’s more important, noticeably costly to the economy, and readily fixable.

As it stands, when a corporation raises capital via debt, it can deduct the returns to debt – that is, the interest – from its tax bill, as an expense. But when it raises capital via stock – equity – it cannot deduct dividends from its tax bill; those are payments out of the company’s profit. The consequence is that corporations prefer debt to equity.

That preference for debt leads to less flexible corporate capital structures. Some companies get stuck with too much debt, which they cannot unwind quickly or effectively enough, disrupting their operations and undermining investment. Indeed, the tax code’s more favorable treatment of debt leads to more corporate failures – and a bigger banking sector that handles that extra, tax-induced debt.

The problem can be fixed and the fixing can be done while keeping the corporate tax bill the same overall. In fact, this is entirely achievable: Michael Tröge and I outlined an effective approach in a PS commentary in 2013. Others have also put forward good approaches. This would do far more for US economic health than taxing buybacks. But it is technical, doesn’t grab headlines, and has no constituency beyond tax policymakers and some academics. The average American voter is certainly not going to get fired up about it. But good policymakers in Congress and elsewhere in Washington should.

BY THE WAY . . .

MJR: No society has tolerated a purely profit-focused business sector for long. Societies always slow the profit machine down and soften the harsh edges. But they do so to different degrees and by different means. And while the degree of slowdown was less in the US than in Europe, it wasn’t zero.

For well over a century, the US kept financial institutions weaker than they naturally would have become. When banks were America’s central financial institution, they were prohibited from establishing branches across state lines and limited in what they were allowed to do in business. The political goal was to prevent them from becoming national powers, as they often were in Europe.

European countries have their own ways of blunting banks’ power, including tighter labor-market regulations, more rules limiting the discretion of corporate management, and greater government direction of the economy – and even of the banks themselves – than in the US. Germany’s law on codetermination, which requires that a large company’s employees elect representatives to fill half the seats in its boardroom, comes to mind.

In the US, larger firms did not face intense shareholder pressure until the end of the twentieth century, with the emergence of alternative paths for exercising financial power – such as hostile takeovers, activist hedge funds, and engaged institutional investors. But it was not long before the government began erecting barriers on these paths, partly in response to pressure from the public and partly in response to pressure from executives. Hostile takeovers were largely defeated via legal roadblocks by the beginning of the 1990s. And today, there are proposals to curtail the power of activist shareholders. The desire to weaken financial power and soften tight profit-making lies behind a number of developments in the last few decades.

MJR: Not just any regulation – good, cost-effective regulation. But yes, my goal was to show that companies with market power – companies that did not face intense competition – had more leeway to accommodate pressures to pursue a public “purpose.” Companies in intensely competitive markets cannot afford to give stakeholder capitalism much more than lip service, unless the pro-stakeholder actions confer benefits – say, motivating employees or boosting profits through branding. But companies in weakly competitive industries, the evidence shows, do accommodate those pressures, somewhat. For example, they tend to pay employees better.

But this is a weak basis for hope that corporations will advance the public good, say, by protecting the environment or supporting progress toward a more politically stable distribution of income. All it tells us is that some companies accommodate purpose pressures somewhat more than others do. It would be far better to strengthen social stability by developing a more progressive tax code, and advance environmental goals by implementing thoughtfully devised, cost-effective rules.