How Incentives for Long-Term Management Backfire

To hear long-term investors tell it, company executives have embraced short-term thinking like never before. Two obvious pieces of evidence: The use of earnings for share buybacks that cost more than they’re worth, and dividend increases that divert cash from long-term investment. Four hundred seventy-one companies in the S&P 500 bought back stock last year, and 372 companies expanded their dividends — actions undertaken in spite of the need to invest heavily to up with global market changes.

Why would executives, charged with sustainable value creation, put so much focus on short-term maneuvers like distributing earnings instead of reinvesting them? Why isn’t more of that cash going into developing businesses for long-term gains — the big, outsized gains that come from big bets on the future? Among many good explanations is one that deserves more airtime: compensation design changes stemming from recent reforms that, ironically, were meant to benefit long-term shareholders.

This is a classic story of unintended consequences — inadvertently short-circuiting long-term management — to the detriment of companies, investors, and the economy. The normal culprits for short-termism are short-term-minded hedge-fund managers and activist shareholders, as well as CEOs worried about big bet investments with uncertain paybacks. But one other big factor has been hiding in plain sight: The efforts of corporate-governance activists and proxy advisers, empowered by the “Say on Pay” votes mandated by Dodd-Frank reforms, to stress transparency and pay for performance.

View the full article as it was originally published.