In early 1990 the National Academy of Engineering formed a Committee on Time Horizons and Technology Investments (p. iii) to explore the impact of time horizons on the development and deployment of both product and process technologies by U.S. corporations. The committee solicited, received, and discussed both written and oral background and insights, but since the study, by design, explored an undeveloped and poorly understood issue, the findings and recommendations in this report draw relatively more on the experience and insights of the committee members and relatively less on earlier empirical or theoretical work.
The committee concluded that there is clear justification for concern over U.S. corporate time horizons. There are significant numbers of industries, or segments of industry, in which short-horizon behavior seems to be both the norm and a considerable source of competitive disadvantage. In addition, there is macroeconomic evidence—low relative rates of investment in long-lived assets and in R&D—that appears to indicate a broad-based tendency toward short-term planning and performance criteria on the part of U.S. industry.
However, the committee found that the common presentation of time horizons in U.S. companies—that U.S. executives are generally near-term oriented and pursue only short-term goals—is too simplistic. Time horizons for technology investments should, and do, vary widely by industry, product, and business activity. It is also clear that short time horizons are not a universal problem for U.S. companies; there are a number of successful U.S. companies operating in industries that require relatively long time horizons for investments.
Near-term orientation in a company can be characterized as a preference for a portfolio of investments that are likely to yield returns in the near future. In many cases, such preferences are rational reflections of technological and marketplace uncertainty and the investment risk they create. These are natural countervailing forces to longer-term planning and investing. This link between risk and time horizons is also quite explicit in the role that capital costs and investment hurdle rates (the discount rates used in company decision making) play in investment decision making in companies; the more risky the project or venture, the more likely it is that both financial markets and internal management decision-making processes will require a higher expected return.
The relationship between risk and investment time horizons is particularly important with regard to investments in the development and deployment of new product or process technologies. Investments in technology-dependent ventures may, in early years, create largely intangible assets, investments may be illiquid for long periods of time as projects can be slow to mature, and they are exposed to both normal business risk and technology-related uncertainty. As a result, technology investments often carry a substantial (formal or informal) risk premium. Although some of the risk is irreducible, a substantial portion reflects the capability of a company in bringing a competitive new product to market or in introducing a substantial process innovation. This implies that adoption of short time horizons in technology-dependent investments is a result of a company's inability to manage technology effectively. Companies with deep and genuine competence in commercial application of technology will have a distinct advantage in adopting longer time horizons for technology investments because they are able to reduce the risk of those investments.
Important aspects of any company's options, practices, and time horizons are also created by (1) the specific competitive status of a company, marketplace and technological uncertainty, and the abilities of a company's board of directors and executive managers to deal with uncertainty; (2) the expectations of investors (the cost and patience of capital) and the way those expectations interact with the financial structure and investment practices of a company; and (3) the design and implementation of government policy. The diversity of influences on corporate time horizons strongly imply that no single actor can unilaterally lengthen investment time horizons. The federal government, boards of directors, and company management all need to act if U.S. technology investment time horizons are to be lengthened.
Boards of directors and the top management they select are uniquely responsible for a company's future. Thus, if a public company's performance is weak because of shortsighted investment behavior, it is ultimately a failure of its board of directors. The board of directors significantly influences
the time horizons of a company through the selection and development of senior management. To be effective at governing a corporation, a board of directors should be attentive to the importance of balance within the senior management team with regard to (1) the age distribution of senior management; (2) the degree to which there are high-quality, identifiable champions for the initiatives that should mature into a company's core businesses in the next decade; and (3) the balance between members of the senior management team focusing on near-term problems and those focusing on the long-term future of the company. Boards of directors should link compensation packages for their senior executives to their performance in developing and implementing plans for the long-term performance of the company. Also, because of the special characteristics of ventures or plans that depend heavily on the use of technology, it is crucial that boards of directors understand commercial technological innovation.
Since the actions of boards of directors are crucial to the time horizons of a company, so are the methods by which directors are selected, compensated, and removed. First, selection of board members should not be an exclusive prerogative or responsibility of the chief executive officer (CEO). Second, corporate governance might be improved by increasing the financial stake that outside directors have in the corporation by requiring that they own shares at least equal in value to a specified multiple of their annual fees as directors. This measure is intended to link board member compensation as directly as possible to long-term stock performance. It is important to note that directors' compensation schemes are not a cure-all for the many perceived ills of boards of directors of public companies.
The committee recommends that corporate boards have nominating committees operating independently of the CEO in choosing new board members and that these nominating committees, in technology-driven companies, give more weight to technological skill as well as business experience in selecting new board members.
The committee recommends that corporations move to increase the financial stake that their directors have in the corporation and that a significant part of directors' compensation be paid in stock or stock options.
Senior management plays a very important role with regard to time horizons in at least three ways: (1) constancy of purpose coupled with flexibility in the development and execution of corporate strategy; (2) design and implementation of career development systems and compensation schemes that promote attention to longer-term corporate goals; and (3) design and choice of decision-making methods and measurement tools that suit the demands and uncertainties of technology-dependent investments.
The committee recommends that a greater portion of the compensation of managers who are in a position to influence the long-range technological performance of a corporation be granted in stock or stock options. The options should not be exercisable for several years—perhaps five years—and should last for a number of years—perhaps ten years.
The committee recommends that bonuses paid to managers with scope and authority over long-term performance be based not just on the previous year's performance, but on multiple years' accomplishments.
The committee recommends that companies actively reconsider the way they use investment decision-making tools such as discounted cash flow analysis, especially with regard to decisions involving new or continuing investments in technology development and deployment. Faulty or unrecognized implicit assumptions, lack of attention to strategic considerations, and poor handling of technological or market uncertainty in the use these tools can critically damage a company's decision making about technology investments.
The emergence of large institutions as important factors in corporate ownership is an important change affecting the pace and character of restructuring and redirecting U.S. industrial enterprises, with possible effects on corporate time horizons. However, even in the context of this trend in capital markets, corporate senior managers continue to have some influence over a company's cost of capital, and thereby exercise control over one determinant of investment time horizons. Managements and boards of directors can (1) affect how markets perceive the firm's potential as an investment opportunity by a variety of actions, including those that establish long-term relationships with key participants, (2) control the capital structure and have some influence on the ownership structure of the company, and (3) take advantage of opportunities for project or venture risk sharing to reduce capital costs.
The committee recommends that managements and boards of directors of companies dependent on long-horizon technological developments (a) implement investor-relations strategies that aggressively and clearly communicate the technological prospects of a company; (b) work to develop long-term relationships with lenders and equity investors; and (c) aggressively pursue joint ventures or other arrangements to reduce the risk of specific technological ventures.
With regard to international differences in the market cost of capital (defined here as financial investors' required expected return), national dif-
ferences in rates for debt are not likely to exist except for relatively short-lived fluctuations arising from national economic or monetary policies. However, national differences in the market cost of equity are likely to persist at some level, and U.S. companies should prepare themselves to operate with some disadvantage in this area.
The committee recommends that the federal government move to allow longer investment time horizons for U.S. corporations through tax policy changes designed to reduce the pretax cost of equity capital.
Other government policies and investments also have a pervasive, important, and often positive influence on the business environment and economic development of the United States. Of these influences, this report deals only with the impact of government investments and regulatory policies on investment time horizons.
Regulations and legal procedures can either increase or decrease the risk faced by private investment. As such, some regulations lengthen corporate time horizons, while other regulations, or legal constraints that introduce substantial unpredictability, can cause firms to shorten their time horizons. The importance of government policies with regard to the regulation and creation of markets needs to be acknowledged, and capability in the use of such policies to support long-term investment should be strengthened.
The committee recommends that the federal government invest in improving the efficiency and timeliness of its regulatory, patent, and licensing procedures.
With regard to government investments, the government creates complementary assets—publicly provided infrastructures or services that permit, support, or work in conjunction with private investments in physical or human capital or R&D. Such assets can reduce the risk of related private investments and allow private companies to adopt longer time horizons for their investment decisions. Publicly supported research and development and public infrastructure are two primary examples.
The committee recommends that the budgetary process for the federal government include more explicit consideration of the degree to which federal expenditures support the creation of long-lived physical and human capital or a knowledge base. Preference should be given to those expenditures that will generate returns for long periods of time and contribute to lengthening the time horizons of private-sector investments in the development and deployment of technology.