The Issue and the Approach
All too often American management is under pressure to improve the bottom line in the next quarter, without regard to how their actions will affect business in the future. This problem is not simply a result of myopic management; it is systemic. The cost of capital, budget and trade deficits, the tax system and the pressure of financial markets all contribute to the problem.
—Council on Competitiveness, Picking Up the Pace: The Commercial Challenge to American Innovation (Washington, D.C., 1988), p. 11.
It is frequently argued that U.S. technology-intensive corporations have shorter time horizons for planning and investment than do their principal Japanese and German competitors. As such, the near-term orientation of U.S. companies is often cited as the headwaters of a cascading sequence of events that threaten U.S. economic welfare:
Companies with time horizons that are too short invest too little in the development and deployment of technologies, activities that often take considerable time to come to fruition.
Underinvestment in long-horizon, technology-oriented projects by the private sector slows overall U.S. productivity growth rates, diminishing the relative standard of living of U.S. citizens.
Underinvestment in long-horizon, technology-oriented projects also weakens specific U.S. companies in global competition with companies based in other nations, many of which appear to do a better job of investing for the long term.
The loss of market share to foreign producers who are better at investing for long-horizon gains threatens U.S. economic security and further erodes the U.S. standard of living.
This argument is explicitly or implicitly offered as a partial explanation for U.S. economic problems in a host of studies of U.S. competitiveness performed over the past 15 years. The argument is widely accepted, and an obvious potential cause—a relatively high cost of capital in the United States—is often targeted in policy discussions. Despite its wide acceptance, the argument about the near-term orientation of U.S. companies has rarely been explored in any depth. Are short time horizons a ubiquitous phenomenon in U.S. industry, are they characteristic of only some industrial sectors, or of only small or large companies? What would explain a tendency toward short time horizons? Is there an identifiable link between lengthened planning and investment time horizons and improvement in corporate performance? Many very successful companies constantly seek to shorten their operating time horizons—by focusing research efforts more sharply on potentially profitable projects, by getting new products to market more quickly, by generating revenues from investments in plant and equipment as soon as possible, and by quickly and successfully instituting quality programs that increase profits. How can the assertion that U.S. companies are too shortsighted be reconciled with studies that show that the best-managed companies constantly strive to shorten the time frame of many activities? These questions, and similar related concerns, motivated the study.
THE APPROACH AND METHOD OF THE STUDY
In early 1990 the National Academy of Engineering formed the Committee on Time Horizons and Technology Investments (p. iii) to explore the determinants of investment time horizons, specifically with regard to the impact of time horizons on technology development and deployment, of both product and process technologies, by U.S. corporations. In addition to the committee's deliberations, the two-year exploration of time horizons and technology investments involved (1) two workshops at which members of the committee were joined by experts—from both academia and business—in finance, general management, employee and executive compensation, R&D and production management, and economics; and (2) a survey study of CEO's perceptions of the cost of capital (published as Appendix A to this report) commissioned by the committee and performed by Joseph Morone and Albert Paulson, members of the faculty of the business school of Rensselaer Polytechnic Institute.
Early in the process the committee discovered that there was no explicit, widely accepted definition of time horizons; nor was there much implicit agreement about the concept, its role in business activities, or its
impact on U.S. economic performance. Chapter 2 makes its contribution simply by explict definition and discussion of ''time horizons'' and the relationship of time horizons to investments in technology development and deployment by companies.
Chapters 3, 4, and 5 explore and develop various influences on the time horizons and technology investment decisions of corporations. Chapter 3 addresses the roles of management and boards of directors in determining investment horizons and recommends strategies or approaches by which corporate executives can remove internal biases toward noncompetitive time horizons or mitigate the impact of external pressures to adopt noncompetitive time horizons.
Chapter 4 addresses the relationship of capital costs to investment time horizons. The chapter takes as its starting point the large and growing literature on national and corporate competitiveness, which often implies a direct, simple, and ironclad relationship between relatively high-average national capital costs, a perceived trend toward short-term trading in U.S. financial markets, and investment time horizons that are too short. The chapter reflects the committee's general finding that the relationship between capital costs and investment time horizons is complex, variable, and depends a great deal on the specific characteristics of the source of marginal capital, on the structure and practices of the company investing the marginal capital, and on the investment itself. The chapter makes some recommendations about private strategies and public policies to reduce harmful impacts that capital costs may have on time horizons for investments.
Chapter 5 examines the role of government investments and regulatory policies on corporate investment time horizons. The chapter is explicitly selective in dealing only with these two types of government influences on investment time horizons. Tax and fiscal policies (aspects of which are addressed in Chapter 4), and the specifics of regulation by the Securities and Exchange Commission, trade policy, antitrust policy, or intellectual property rights all are likely to affect the investment time horizons of U.S. companies. An in-depth treatment of such issues would stretch well beyond the expertise of the committee, which chose instead to focus its attention on two types of government influence on corporate time horizons that are not often explored or developed. Focusing on government investments and regulatory procedures, the chapter recommends actions and approaches through which government policymakers can productively lengthen the time horizons of private investment decisions in the United States.
The committee is grateful to the participants in the workshops for their numerous insights and contributions, and to Professors Morone and Paulson for their work, but the findings and recommendations in this report are based on the experience and consensus judgment of the committee. This statement, which is true of all Academy reports, is particularly important in
this case because of the lack of empirical work or well-developed theory on investment time horizons; the study, by design, explored an undeveloped and poorly understood issue and the findings and recommendations, therefore, draw relatively more on the experience and insights of the committee members and relatively less on earlier empirical or theoretical work.
DO U.S. CORPORATE EXECUTIVES HAVE SHORT TIME HORIZONS?
Are some U.S. companies, or segments of industry systematically underinvesting in technology-related opportunities because of short-term decision making and investment bias? While there is considerable anecdotal evidence that U.S. firms behave in shortsighted ways, it is not an easy matter to generalize. In fact, there is remarkably consistent evidence that many U.S. firms have a rational spectrum of time horizons, from short to quite long. The most obvious is that some U.S. industrial sectors with high technical content and very long product cycles—for example, aerospace, pharmaceuticals, and chemicals—are highly effective international competitors. In addition, within almost every industry are examples of U.S. companies that perform exceedingly well and appear to have long planning and resource commitment time horizons. How can the performance of these industries and companies be reconciled with an assertion that U.S. companies are uniformly shortsighted?
The evidence that U.S. firms are shortsighted comes in primarily three forms. First, a large number of industry-specific competitiveness studies—cases of head-to-head competition between U.S. and foreign firms—have identified shortsighted behavior on the part of U.S. companies as one of the "fatal flaws" of the U.S. companies involved. The recent study of the MIT Commission on Industrial Productivity (Dertouzos et al., 1989) found that short time horizons contributed to the problems of the U.S. automobile, consumer electronics, machine tool, semiconductor, computer, copier, steel, and textile industries. The Commission was encouraged that the U.S. chemical and commercial aircraft industries were not apparently preoccupied with short-term goals. An earlier series of studies by committees of the National Academy of Engineering and the National Research Council found similar evidence of short-term behavior in several of the seven industries they studied (Steel and Hannay, 1985). In the summary of the findings of those studies, particular attention was drawn to the problems of steel and semiconductors because of the cyclic nature of their markets, abetted in the case of semiconductors by rapid obsolescence of product generations and of production equipment.
The failure of some U.S. firms—relative to their Japanese competitors—to invest adequately during downturns in demand is now part of a fairly standard story about competitive dynamics and the shortsightedness
of U.S. executives. One well-known example is the semiconductor memories industry. Major U.S. companies chose to invest less in new products and new plant and equipment than foreign competitors during the time of slack demand. When demand increased, usually for the next generation of product, U.S. companies fell behind in their ability to respond while their competitors gained market share. As a result, the fate of some U.S. semiconductor firms was to lose market share coming out of every period of slack demand and eventually to leave the business. The short-term goals that executives choose to pursue—in particular the desire to earn "predicted" profits—seem to have hurt the companies in the long run. Use of a different goal—long-term profitable market share, for example—might have yielded different results.
MACROECONOMIC EVIDENCE: RELATIVE RATES OF INVESTMENT IN FIXED CAPITAL AND R&D
A second type of evidence that U.S. companies suffer from time horizons that are too short is the low relative levels of investment in long-lived assets by U.S. corporations. Between 1973 and 1985, manufacturing gross fixed capital formation as a share of manufacturing gross domestic product averaged 12.4 percent in the United States and 19.1 percent in Japan, a ratio of 1.5 in Japan's favor. From 1976 to 1988, investment in machinery and equipment in Japan varied from 14.9 percent to 20.6 percent of gross national product (GNP). In the United States it ranged from 7.5 to 9.0 percent. Rates of capital formation as a percentage of gross domestic product in other competitor nations—West Germany (before unification), France, the United Kingdom and Canada—were lower than in Japan but almost universally higher than in the United States. The last years of the 1980s were the most dramatic as Japanese investment in manufacturing increased by more than 25 percent between 1988 and 1989 while U.S. investment went up by only 9 percent.1
A third type of evidence that indicates short-term behavior on the part of U.S. companies is the low relative levels of investment in research and development—usually relatively risky investments not expected to pay off quickly. The United States actually leads the world's industrialized nations in terms of absolute expenditures on research and development, spending almost 2.5 times more than Japan. As a percentage of GNP, however, U.S.
R&D expenditures are roughly equivalent to those of Japan, the United Kingdom, West Germany (before unification), and France. When defense-related R&D is removed, however, the results are quite different; the United States lags a full percentage point behind Japan and Germany in R&D spending as a percentage of GNP (in absolute terms, in 1987, the United States spent about $68 billion to Japan's $39 billion and Germany's $18 billion).
SUMMARY AND CONCLUSION
Although there is little agreement on the meaning of short time horizons, there is clear justification for concern over U.S. corporate investment 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, though a substantial number of U.S. companies and industries exhibit long-term behavior. 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.
Evidence of short time horizons must, of course, be drawn from the recent U.S. economic history and from the assertion that U.S. companies have short time horizons is most closely related to concerns about U.S. industrial competitiveness in global markets. It is important to note, however, that the time horizons of U.S. private investment decisions will be important in a variety of contexts in the foreseeable future. In particular, U.S. businesses have seldom had to face such an uncertain and unstable future as they do today. Among the events defining the environment for business are the apparent end of the cold war and the impact of that change on U.S. policy and on defense industries; the demands of environmental protection and the requirements of capital for building and repairing infrastructures; and a relatively recently discovered pervasive weakness in the U.S. banking and insurance industries. The ability of U.S. companies to develop and maintain long-horizon investment plans—many of which must deal with the development or deployment of new technologies—through what is likely to be a period of substantial turmoil and restructuring will determine the economic prosperity and national security of the United States well into the twenty-first century.