The following article by Brookings Senior Fellows in Governance Studies William A. Galston and Elaine C. Kamarck, is cross-posted from Brookings:
In her economic speech in New York on Monday, Hillary Clinton did what no one thought she would do–she took on the excesses of Wall Street. We couldn’t agree with her more. It is good policy and good campaign strategy.
As the American economy has struggled to regain its footing in the wake of the great recession we’ve heard many explanations for slow growth and stagnant incomes in the 21st century American economy. High on the list are globalization and the role the information technology revolution is playing in the disappearance of manufacturing jobs and, more recently, routine service sector jobs as well.
Although the decisions we make can shape their effects, these big trends are here to stay. But another set of problems is in principle more malleable. These problems arise from the “financialization” of the American economy–problems that we have written about and which Hillary, in a bold speech, has now placed square on the 2016 agenda.
In recent years, certain incentives have become so powerful and pervasive in the private sector that they have tilted corporate decision-making in the direction of short term gains. No one set out to create this myopic system, which arose piecemeal over a period of decades. But taken together, these perverse new micro-incentives have created a macroeconomic problem–the taking of short term profits at the expense of investment in long term growth. These incentives include: the proliferation of stock buybacks and dividends, the increase in non-cash compensation, the fixation on quarterly earnings and the rise of activist investors.
The proliferation of share repurchases, we argue in a recent paper, has had numerous bad effects on investments, on wages for average workers, and on the willingness of firms to adopt a long-term perspective. The surge in non-cash compensation for CEOs has intensified these problems. In the name of better aligning managers’ incentives with the interests of their companies, it has created perverse incentives to manage earnings and to report results that diverge from actual corporate performance. It diminishes incentives to seek productive investments and to make the kinds of commitments–to research and development, for example–that will show up in the bottom line five or ten years hence, not in the next quarter’s earnings.
There is a compelling case, we conclude, for reining in both share repurchases and the use of stock awards and options to compensate managers. To this end, we propose the following steps:
- Reverse Reagan-era regulatory changes that opened the floodgates for massive stock buy-backs
- Improve disclosure practices
- Strengthen sustainability standards in 10-K reporting
- Toughen executive compensation rules
- Reform the taxation of executive compensation
We are not against having investors make a good profit but, like many in the business community itself, we have come to believe that the incentive structure today is creating a short term mindset that is detrimental to the kind of long-term growth that produces good jobs and rising wages. To re-balance our economy we must restructure the incentives that shape the decisions of CEOs and boards of directors. By reining in stock buybacks and reducing short-term equity gains from compensation packages, we have argued, we can move significantly down this road. And we should.
PDF of the Galston/Kamarch paper
Galston elaborates on Clinton’s strategy in his latest Wall St. Journal column.