How Short-Termism Impacts Public and Private R&D Investments

By Erin Smith

Tuesday, June 7, 2016

Shortly after taking over as chief executive officer at Lockheed Martin in 1995, Norman Augustine laid out a five-year investment plan focused heavily on research and development. He expected investors to embrace the proven benefits of R&D investments for the company’s long-term health. Instead, his foresight was rewarded with a stock selloff that sent share prices plummeting. Examples like this are becoming more frequent, illustrating that investors often see long-term thinking as a liability. This creates immense pressure for business executives to maximize short-term gain. Growing evidence indicates these factors are contributing to an investment culture often referred to as “short-termism.” The impact on R&D investment, especially in energy, is significant.

As investors have come to favor shorter payback periods, recent changes in executive compensation—such as the sharp growth of bonuses as a percentage of executive income over the past 20 years—have also reinforced short-termism. The rise in the practice of buying back shares of a company provides persuasive evidence of this shift. Since a company cannot act as its own shareholder, the “buy-back” stocks are absorbed by the company and shrink the number of available shares. This in turn drives up the value of each remaining share and can lead to higher executive compensation.

As it gets harder for companies to invest in the early stage research, they increasingly focus on later stage research that can bring products to market more quickly.

Studies show that the proportion of money spent on buy-backs is near its highest level since 2008, and one study concluded that between 2003 and 2012, companies in the S&P 500 spent 54 percent of their earnings to buy back their own stock. There are certainly legitimate reasons for companies to engage in this practice, but the rapid growth in the number of companies doing so suggests something else. The troubling result is that the proportion of money spent on long-term growth investments like capital equipment is the lowest on record.

Augustine’s example illustrates how short-term thinking has changed the nature of corporate R&D, traditionally considered a long-term investment. As it gets harder for companies to invest in the early stage research, they increasingly focus on later stage research that can bring products to market more quickly. This can have serious consequences for long-term competitiveness by limiting a company’s access and familiarity with the cutting edge of research in their industries. As basic research inside industry has fallen, the role of the federal government in supporting basic research and, by extension, the competitiveness of American companies, has grown. This increasing research polarity risks creating silos in which applied R&D is undertaken by the private sector and basic research is left largely to the federal government. Without strong public-private partnerships, this arrangement can limit the cross-pollination of ideas so critical to competitiveness in rapidly evolving technology sectors.

If we fail to maintain the shared base of knowledge that has served as America’s economic foundation, we risk destroying the primary source of tomorrow’s prosperity.

Stagnant federal investments in research make this dynamic even more challenging, especially as other nations increase their own support for R&D. This is not just a distant, possible future, but a risk we face today—evidenced by the United States coming in at tenth in the latest global innovation rankings. If we fail to maintain the shared base of knowledge that has served as the foundation of American economic prowess for decades, we risk destroying the primary source of tomorrow’s prosperity.

The energy sector is particularly vulnerable to this dynamic. High capital costs and lengthy asset turnover periods combine with a complex and uncertain regulatory environment to make private sector support for energy research especially difficult. Recognizing this, the Bipartisan Policy Center recommended that Congress significantly increase federal investments in energy R&D and seek out ways to promote private innovation. During last year’s Paris climate negotiations, the United States joined 19 other governments in committing to double investments in energy R&D over the next five years—a welcome step. A group of wealthy investors also formed the Breakthrough Energy Coalition, bucking the short-termism trend by taking a long-term approach to investing in clean energy technology. Of course, not every investor can afford to be so patient. The increasing shift toward short-termism in corporate R&D makes federal investments in early stage and high-risk research, along with strong public-private partnerships, more important than ever.

KEYWORDS: NORMAN AUGUSTINE