The competitiveness of U.S. corporations, particularly manufacturing firms, declined during the 1980s. The decade witnessed serious inroads by foreign firms into traditional domestic markets. In capital goods, for example, the import penetration ratio rose from less than 15 percent to nearly 40 percent. Some indicators of U.S. competitiveness have stabilized or shown some improvement in the first half of the 1990s, largely as a result of exchange rate movements and a strong U.S. macroeconomy. However, the productivity of foreign manufacturers, notably those in Japan, has grown faster than that of U.S. firms for more than two decades.1 This trend suggests that foreign corporations will continue to present stiff challenges to U.S. firms in the years ahead.
Many explanations have been advanced for the decline in U.S. industrial competitiveness during the 1980s. They frequently assign a central role to differences in the willingness of U.S. and foreign firms to forgo short-term returns in favor of long-term rewards. These differences in “time horizons” can manifest themselves in differences in R&D, plant, and equipment investment; training for workers with firm-specific skills; and willingness to undertake long-term market development programs. The interest in corporate time horizons has generated a lively academic and policy debate about the cost of capital facing firms in different nations. The cost of capital is an important component of the discount rate used in evaluating long-term projects and is increasingly viewed as a source of competitive advantage or disadvantage in world markets.2
Although the time horizons of U.S. firms have been implicitly at issue throughout the debates on competitiveness policy, there is little direct evidence on corporate planning horizons or on their changes during the 1980s.3 In this study, we attempt to bridge the gap between analytical studies of corporate capital budgeting and the policy debate on corporate competitiveness.
To investigate corporate time horizons and hurdle rates, we surveyed the CEOs of all firms in the Fortune 1,000. We asked them to describe their capital budgeting practices, provide information about hurdle rates and other determinants of their firms’ time horizons, and evaluate the effects of a number of different policies on their firms’ investment planning horizons. Here we report our survey findings, which focus on hurdle rates, the capital budgeting process, and the effects of various factors on investment in R&D and physical assets.
1. For recent data on manufacturing productivity in the United States, Japan, and other G-7 nations, see:
E.R. Dean and M.K. Sherwood, “Manufacturing Costs, Productivity, and Competitiveness, 1979–1993,” Monthly Labor Review 117 (1994): 3–16.
2. For a summary of the policy debate about the role of time horizons in exacerbating the competitiveness problems of U.S. firms, see:
M. Jacobs, Short-Term America (Boston: Harvard Business School Press, 1991).
For a survey of studies on the cost of capital in U.S. and Japanese firms, see:
J.M. Poterba, “Comparing the Cost of Capital in the United States and Japan: A Survey of Methods,” Federal Reserve Bank of New York Quarterly Bulletin, Winter 1991, pp. 20–32.
For a discussion of various policy measures that might lengthen corporate time horizons, see:
National Research Council Board on Science, Technology, and Economic Policy, Investing for Productivity and Prosperity (Washington, D.C.: National Academy Press, 1994).
3. There are dozens of studies of corporate capital budgeting practices. See, for example:
L. Schall, G. Sundem, and W. Geijsbeek, Jr., “Survey and Analysis of Capital Budgeting Methods,” Journal of Finance 33 (1978): 281–287; and
J. Binder and J.S. Chaput, “A Positive Analysis of Corporate Capital Budgeting Practices” (Chicago: University of Illinois-Chicago, mimeo, 1991).
However, the competitiveness policy debate has largely ignored them.
4. A copy of the survey is available from the authors on request.
5. In April 1991, we also sent the questionnaire by fax to the fifty largest firms in Germany, Japan, and the United Kingdom. We discuss these responses later.
6. We view both the long-term R&D share and the hurdle rate as measures of corporate time horizons. We therefore examined their correlation in our sample and found that the share of long-term R&D is (weakly) negatively correlated with the real hurdle rate.
7. Ibbotson Associates reports a geometric average return of 10.3 percent (nominal) on common stocks of large firms, 12.4 percent on common stocks of small firms, 5.6 percent on long-term corporate bonds, and an inflation rate of 3.1 percent for the 1926–1993 period. See:
Ibbotson Associates, Stocks, Bonds, Bills, and Inflation: 1994 Yearbook (Chicago: Ibbotson Associates, 1994).
8. M.S. Feldstein, J.M. Poterba, and L. Dicks-Mireaux, “The Effective Tax Rate and the Pretax Rate of Return,” Journal of Public Economics 21 (1983): 129–158.
9. Competitors of the firms we analyzed may not be representative of Asian or European firms; they may be more export oriented and potentially longer horizon firms than companies engaged only in domestic sales.
10. Another explanation for this finding is that the CEOs who responded were more attuned to problems of time horizons than a purely random sample. Their firms could typically have longer time horizons than their domestic competitors.
11. We present detailed information on the responses to each question because two questions may have identical mean responses but quite different distributions in the intensity of views. Two questions may have equal average responses (say, 3), but one might have an equal number of 2, 3, and 4 responses, suggesting no very strong views on this policy, while another could have the same mean but half of the respondents indicating 1 and the other half 5. Table 5 provides this information.
12. This is a surprising finding since a “rifle-shot” capital gains tax cut for equities would make them more attractive than other gain-producing assets, reducing the cost of equity more than a capital gains tax cut for all assets.