if the Future Mattered
Social and Economic Theory into Human Behavior
1: Investment as a Link between Present and Future
Chapter 1: Capital Choices: National Systems of
Michael E. Porter
Harvard Business School, Harvard University, Cambridge,
essay surveys in a short space the complex topic
of national investment practices. It is particularly
important to keep in mind the complexity of the
topic because the proposals that emerge from this
analysis emphasize the interdependence of all parts
of the system. Readers who wish to see the arguments
laid out at greater length are directed to Capital
Choices: changing the Way America Invests in Industry,
research report available from the Council on Competitiveness
in Washington, DC.
this introductory section, the essay is divided
into two parts. Part 1 describes how the U.S. investment
system works, considering the global context and
the external and internal capital markets within
which it must operate, as well as the issues of
positive (and negative) social externalities to
private investment behavior. Some evidence is given
in support of the widespread belief that there is
a problem with U.S. investing, especially in failing
to align private with social interests, and especially
in comparison with Japan and Germany. The largest
part of this section describes how investment decisions
are determined in the United States.
2 lays out the specific institutional, legal, and
other factors that, taken together, are particularly
important in creating the existing problems in the
U.S. system of investment allocation. A number of
concrete suggestions are then made for how the different
actors in the system (e.g., policymakers, owners,
managers, and institutional investors) can move
to reform the system.
intimately links the present with the future. It
is crucial not only for maintaining an economy's
current physical and human assets but also for upgrading
those assets to new and more sophisticate future
uses. Yet the U.S. system of allocating investment
capital, as it now exists, threatens the long-term
growth of the national economy. Although the U.S.
system has many strengths, including efficiency,
flexibility, responsiveness and high rates of corporate
profit, it does not seem to be the most effective
in directing capital to those firms that can deploy
it most productively and, within firms, to the most
productive investment projects. Many U.S. firms
invest too little in those assets and capabilities
most required for competitiveness, while others
waste capital on investments with limited financial
or social rewards.
critics frequently blame the shortcomings of U.S.
industry on a short time horizon, ineffective corporate
governance, or a high cost of capital, these concerns
are just symptoms of a larger problem involving
the entire system of allocating investment capital
within and across companies.
U.S. system of capital allocation creates a divergence
of interests between owners and corporations, impeding
the flow of capital to those corporate investments
that offer the greatest payoffs. U.S. owners, investment
managers, directors, managers, and employees are
thus trapped in a system in which all are acting
rationally, but none is satisfied. The U.S. system
also has difficulty aligning the interests of private
investors and corporations with those of society
as a whole, including employees, suppliers, and
local educational institutions.
How the System Works
Competitiveness in the Global Context
context within which we must understand the structure
of investment allocations is a world in which the
rules of international competition are quite different
from the concepts taught to economists and businesspersons
20 years ago. Classical comparative advantages in
factors of production, such as natural resources
or pools of labor, have been superseded by the globalization
of competition and companies, coupled with the power
of technology to nullify factor disadvantages (see
Porter 1990). Generalized skills and generic scientific
knowledge now move rapidly around the world, and
competitors rapidly assimilate them.
Competitive advantage no longer emerges from optimizing
within fixed factor constraints. Instead, it depends
upon the capacity of a nation's firms to innovate
and upgrade their competitive advantages to more
sophisticated types, a never ending process that
requires sustained investment in a variety of forms.
Firms must invest not only in highly specialized
physical assets but also, increasingly, in specialized
knowledge, skills, and organizational capabilities.
Making some investments that fail is integral and
indeed essential to the dynamic process of innovation
because such investments provide learning or create
capabilities that benefit future investments. An
institutional structure that overly penalizes "bad''
investments may undermine the competitive capability
of firms, industries, and the national economy as
Similarly, parallel investments by diverse competitors
create the most favorable conditions for rapid industry
and firm improvement. An environment in which a
number of competitors invest in pursuing a variety
of strategies but closely observe and respond to
each other's successes and failures seems to create
the conditions for the fastest rate of progress.
It also leads to beneficial segmentation and differentiation
of firms' products and strategies which makes competitive
advantages more sustainable. A structure in which
investment is restricted to a dominant competitor,
or made collectively by a group of rivals, may be
efficient in a narrow sense but is not ultimately
the most productive.
Investments, Social Returns
are many forms of investment, ranging from traditional
plant and equipment to investments in training or
the losses required to enter a new geographic market.
For purposes of simplification, we can divide the
forms of investment into those in physical assets;
those in intangible assets such as R&D, advertising,
employee training and skills development, information
systems, organizational development, or close supplier
relationships; and those in positional assets such
as access to new geographic or product markets.
Investments in physical assets represent a declining
portion of overall corporate investment. The other
"softer" forms of investment are of growing
importance to competition and are also the hardest
to measure and evaluate using traditional approaches
for evaluating investment alternatives.|1 Ironically,
many forms of investment are not treated as such
on corporate books, which has implications for investment
behavior that we will return to later.
The appropriate rate of investment in one form often
depends on making complementary and sequential investments
in others. A physical asset such as a new factory,
for example, may not reach its potential level of
productivity unless there are parallel investments
in intangible assets such as employee training and
product redesign to improve its manufacturability
using the new production technology. Investments
are linked not only at one point in time but also
intertemporally. An investment today, even if unsuccessful,
can create option value for future investments.
Today's R&D, for example, results not only in
today's products and processes but the possibility
of developing those of tomorrow. Finally, investments
in one product area can create benefits for others.
Because of all these types of ""spillovers''
of investments within the firm, the appropriateness
of many discrete investment projects cannot be evaluated
The optimal rate of investment for society may differ
from that for an individual firm because of the
presence of externalities or spillovers from private
investment.|3 These spillovers create benefits for
the economy as a whole (referred to as social returns)
that exceed the private returns that accrue to a
firm's shareholders. Social returns include such
things as potentially higher wages of employees
due to productivity-increasing technology investments;
the greater capabilities (and higher future wages)
of employees that result from investments in training;
and the returns to suppliers, customers, and other
local industries (and their employees) due to spillovers
from a company's investments in technology, research
or training programs at universities. None of these
benefits is reflected in a company's current profits.
Such spillovers are greater within regions and nations
than across national borders.
The difference between private and social returns
varies by form of investment. Investments in intangible
assets such as R&D and training seem to involve
the greatest difference between social and private
returns, while investments in physical assets such
as replacement plant and equipment or real estate
normally involve fewer externalities. For example,
the social returns from R&D have been documented
as being 50 to 100 percent higher than private returns
(see Bernstein and Nadiri 1989; Mansfield 1991).
Note that the forms of investment with the greatest
potential externalities are some of the very same
ones that are expensed in accounting statements
rather than counted as assets and that raise the
most daunting challenges for conventional capital
Given the presence of externalities, a bias toward
overinvestment seems to offer higher social returns
and perhaps also higher long-term private returns.
Private and social returns will tend to converge
more in the long term than in the short term. This
is because the externalities created by the firm's
investments will feed back to benefit the firm.
For example, the suppliers or customers who have
enjoyed positive spillovers may in the future become
more effective suppliers or larger, more sophisticated
customers. Similarly, better-trained employees may
allow entirely new strategies in the future that
reinforce a company's competitive advantage. Note,
however, that the diffusion of a new technology
may lower private returns over time while social
returns stay high. This is one reason why the spread
between private and social returns to R&D is
so great, and why special incentives for R&D
investments (such as patents and R&D tax credits)
of the Problem
A good deal of evidence supports the view that U.S.
industry invests at a lower rate than German and
Japanese industry in many forms of investment and
has a shorter time horizon. The facts, observations,
and anecdotal evidence relating to this view include
rates of investment in property, plant and equipment,
civilian R&D, and intangible assets such as
corporate training and related forms of corporate
human resource development is lower in the United
States than in Japan and Germany (see Farb 1992).
Anecdotal evidence suggests that U.S. firms invest
at a lower rate than their German and Japanese
counterparts in nontraditional forms such as human
resource development, relationships with suppliers,
and start-up losses to enter foreign markets.
Kochan and Osterman (1992) and Blinder and Krueger
(1992), for example, both document a significantly
lower rate of investment by U.S. firms in human
resources.|4 The magnitude of the difference appears
greater in this area than in other investment
The R&D portfolios of U.S. firms include a
smaller share of long-term projects than those
of Japanese and European firms. A survey of CEOs
in the United States, Japan, and Europe by Poterba
and Summers (1992) found that 21 percent of the
projects of U.S. firms were considered long term
compared with 47 percent in Japan and 61 percent
The average holding period of stocks has declined
from over seven years in 1960 to about two years
today (Duttweiler 1991). This decline implies
a dramatic shift in the frequency with which investors
buy and sell corporate equities. It is perhaps
the most telling evidence of shortening investor
these findings present a broadly consistent picture
of lagging U.S. investment, there are some puzzling
and important complexities that seem to defy the overall
pattern. These puzzles derail many simple explanations
for why the United States invests less or has a shorter
time horizon. For example, the U.S. investment (and
competitiveness) problem varies by industry and even
by company: the United States is highly competitive
and invests aggressively in industries such as chemicals,
pharmaceuticals, software, and telecommunications
network equipment. The United States does well in
high-risk, long time horizon start-ups and invests
heavily in emerging industries. Finally, many U.S.
firms seem to have overinvested in unrelated acquisitions.
Any useful understanding of the broad problems we
are addressing must also take account of these apparent
Determinants of Investment
The determinants of investment can be grouped into
three broad categories: the macroeconomic environment
in which all companies operate; the allocation mechanisms
by which capital moves from its holders to investment
projects (it is on this second category that our research
focuses); and the conditions surrounding specific
investment opportunities themselves. (These latter
include characteristics of the particular projects,
companies, industries, and the geographic locations
where investments take place.)
Investment capital is allocated via two distinct but
related markets: the external capital market through
which holders of equity and debt provide capital to
particular companies and the internal capital market
in which companies allocate the internally and externally
generated funds at their disposal to particular investment
programs. There are strong parallels in how these
dual markets function. The equity holder's task of
selecting and monitoring companies in which to invest
bears a strong resemblance to the corporation's task
of selecting and monitoring investment programs. Both
markets also share attributes that will prove crucial
to investment behavior: highly incomplete information
that is costly to gather; the existence of principal-agent
relationships (in some cases, multitiered ones) that
create agency costs; important spillovers or externalities
in investment; and the potential to influence the
results of a given investment through intervention.
Nature of the External Capital Market
The external capital market includes a number of entities.
The first is the holders of equity capital, whom we
will term owners. The second is the agents who, in
some instances, make investment choices on the owners'
behalf. In the United States, investment decisions
involving a large fraction of equity capital are made
by institutional agents, whether they are pension
funds, mutual funds, bank trust departments, or other
money managers. Because owners have incomplete information
about the performance of agents, they must use proxies
in monitoring and evaluation. Agents can be expected
to manage investments in a way that is aligned with
how they are measured and compensated.
A third important entity in the external capital market
is lenders of debt capital. The fourth entity is,
of course, the corporation in which equity is invested
or to which a loan is made. The final important entity
is the board of directors, which is the formal link
between the owners and the corporation.
The way in which the national system for capital allocation
deals with the problem of imperfect information is
crucial to understanding investment behavior. How
owners/agents cope with imperfect information in dealing
with each other and in valuing companies will influence
the particular corporate attributes that influence
stock prices. Management's perception of the ways
in which the external market values their companies
affects internal investment choices. The way in which
managers cope with imperfect information internally
will influence the particular types of investment
projects selected. Finally, the approaches used by
owners/agents to deal with incomplete information
will influence those used by management.
Four characteristics of the external capital market
are of principal importance for investment behavior.
The first is the pattern of share ownership and agency
relationships, which refers to the nature of the owners,
the extent of their representation by agents, and
the size of the stakes held in companies. The second
is the goals of owners and agents, which influence
their desired investment outcomes. The ability to
jointly hold debt and equity is one important influence
on goals, as is the existence of a principal-agent
relationship. The third salient characteristic of
the external market is the approach and information
used by owners/agents to monitor (measure) and value
companies. The final important characteristic is the
ways in which owners/agents can influence management
behavior in the companies whose shares they own.
These separate characteristics of the external capital
market in an economy are interrelated and will tend
over time to become internally consistent. If the
dominant investors are principals who hold large stakes
and are permanent, relationship-driven owners, the
incentive will be present to invest in and accumulate
fundamental knowledge on long-term corporate prospects.
Owners will demand and achieve more influence on management
behavior. Their orientation will be to work with management
to improve performance and sell out only as a last
resort. Conversely, if the pattern of share ownership/agency
relationship is dominated by transaction-driven agents
holding small company stakes who are measured on near-term
appreciation and are dependent on public information,
the incentive will be to employ information-lean index
funds or simple value proxies in monitoring and valuation
rather than to invest in costly fundamental research.
Share holdings will tend to be more transient if agents
can exert little influence on management.
U.S. External Capital Market
In the United States, publicly traded companies increasingly
have a transient ownership base comprised of institutional
investors such as pension funds, mutual funds, or
other money managers that act as agents for individual
investors (see Edwards and Eisenbeis 1992). Such agents
account for at least 55 percent of the public market
and, combined with member firms trading on their own
account, over two-thirds of all trading.
Due to legal constraints on concentrated ownership,
fiduciary requirements that encourage extensive diversification,
and a strong desire for liquidity, U.S. institutional
agents hold portfolios involving small stakes in many,
if not hundreds, of companies. For example, one of
the largest U.S. pension funds, the California Public
Employees Retirement System (CalPERS) reportedly held
stock in over 2,000 U.S. companies in 1990, and its
largest individual stake was 0.71 percent (see White
1991; Sailer 1991). Due to restrictions on bank ownership
of corporate equity, U.S. banks do not normally hold
debt and equity in the same company. Neither do U.S.
insurance companies, although they are not restricted
from doing so.
U.S. institutional agents such as pension funds and
mutual funds, and the managers of such funds, are
typically measured on quarterly or annual appreciation
compared to stock indexes, and they thus seek near-term
appreciation of their shares. Quarterly performance
evaluation encourages the documented practices of
"window dressing" (selling poorly performing
stocks at the end of the year) and "lock-in"
(well-performing portfolios are sold and the investment
managers buy S&P 500 to lock in gains relative
to other funds), although these practices have limited
effect on returns to shareholders. Managers are readily
changed if performance is unsatisfactory. Pension
funds, whose capital gains are not taxed, make buy/sell
choices without considering the trade-off of having
to pay taxes on appreciated stocks sold, which would
encourage longer-term holding. Mutual funds must distribute
income and capital gains annually so that investors
pay taxes each year. This only serves to heighten
the attention of funds to quarterly or annual realized
performance and hence to realizing gains. As a result
of all these circumstances, mutual funds and actively
managed pension funds (which represent 80 percent
of pension assets) hold shares, on average, for just
situation just described -- in which institutional
investors have fragmented stakes in numerous companies,
short expected holding periods, and lack of access
to "inside" information through disclosure
or board membership -- results in a strong tendency
to base buy/sell choices on relatively limited information,
based on those measurable company or industry attributes
that affect near-term stock price movements.
Current earnings are an example of a proxy for corporate
value. Their use is problematical, first, because
accounting earnings do not accurately measure true
earnings. Many investments must be expensed, and as
a result current accounting earnings understate true
earnings in companies where high rates of intangible
investment are needed. Second, even true current earnings
do not accurately measure corporate value because
they fail to measure the firm's competitive position
and its ability to sustain or improve that position
and hence its future earning power. Maximizing
a series of short-term returns is not equivalent to
maximizing long-term returns because of the role
of multiperiod investments. Investments needed to
build skills, capabilities, and market positions,
or to defend existing positions at the expense of
current earnings are penalized by the use of current
earnings as a value proxy.
their large aggregate holdings, U.S. institutional
agents have virtually no real influence on management
behavior. For various legal and regulatory reasons
that will be discussed later, agents rarely hold seats
on the board of directors and have little clout with
management. Index funds, which might be seen as long-term
investors, cannot play this role effectively either.
With their investment philosophy, extreme fragmentation
of ownership, and lack of incentive to invest in information,
index funds have little realistic prospects of credibly
monitoring and influencing management behavior.
Institutional agents are left, then, with the proxy
system as the only direct means of imposing their
views on management. The proxy system, while cumbersome
and ineffective, has been employed with growing frequency
in recent years, with the number of shareholder proposals
increasing from 33 in 1987 to 153 in 1990. The great
majority (91 percent) of shareholder proposals regarding
economic matters, however, have little to do with
strategy or investment behavior but relate to corporate
policies affecting the ease of control changes. Here,
shareholder proposals invariably aim to make takeovers
easier. Given the goals of institutional agents and
their approach to monitoring and valuation, this is
not surprising. Yet many institutions do not even
bother to vote their shares, and there is growing
debate about the responsibility of institutions in
voting proxies as agents for investors.
The only real remedy available to U.S. institutional
agents who are dissatisfied with management decisions
is to sell their shares. The stock prices of out-of-favor
companies are bid down by investors seeking to limit
their losses who are unable to wait (because of their
need for rapid appreciation) for a rebound due to
earnings improvement or for a possible control change.
Successive stock price declines may ultimately create
the potential for acquisition or takeover to unlock
the unrealized value. Arbitrageurs, a largely different
group of investors from institutional agents, provide
a countervailing force that holds up share prices
of companies for which takeover seems likely.
Control changes and voluntary restructurings to forestall
them, then, represent the only real discipline on
management behavior in the U.S. system, given the
limited power of owners and the limited impact of
the proxy system. Unfortunately, this form of discipline
occurs only after protracted decline in corporate
performance. It also involves high transactions costs
and carries with it some potential negatives for long-term
corporate performance. While takeovers and buyouts
can reduce static inefficiency through forced restructuring,
they replace institutional agents with another financially
oriented owner, the LBO firm (ironically, the funding
for takeovers often comes from the very institutional
agents who were the previous shareholders). While
the new owner may have a longer horizon than the previous
ones, most LBO firms are prone to being transaction-driven
and seek to realize gains from selling out or taking
the company public. In addition, the leverage required
to complete the takeover forces asset sales that may
in some cases diminish competitive capabilities and
instill a financial stringency that can make it difficult
to fund investments that do not generate cash quickly,
particularly unexpected ones.
Internal Capital Market
The internal capital market is the system by which
corporations allocate the capital available from both
internal and external sources among competing investment
projects within and across business units. The system
of internal capital allocation in an economy mirrors
and is significantly influenced by the external capital
allocation system. The external market sends signals
that affect how companies are organized and managed.
However, there are also independent influences on
the internal capital allocation process that arise
from laws, regulations, and prevailing management
The most important influences on the internal capital
market parallel those that shape the external market:
the particular goals corporations set, the organizational
principles that govern the relationship between senior
management and units, the particular information and
methods used to value and monitor internal investment
options, and the nature of interventions by senior
management into investment projects. The issue that
will be emphasized here is that of corporate goals.
(For fuller exposition of the other issues, see Porter
Corporate goals are influenced from a number of directions.
One is the legal framework in a nation that defines
corporate purpose, as well as the extent to which
particular corporate goals are codified in law as
the duties and responsibilities of directors and managers.
Particularly significant to corporate goal setting
is the extent to which shareholders' goals are given
explicit legal primacy and how such laws are interpreted
by participants in corporate governance and by the
courts. The way such laws are interpreted and the
risk of lawsuits are as important as the laws themselves
because this influences the sensitivities of managers
and directors and the tests applied in judging their
Also significant in corporate goal setting is the
board of directors. The composition of the board defines
the interests that board members represent and the
knowledge they have available. A board consisting
of major owners, for example, is prone to have a different
orientation than one consisting solely of management.
Also important in understanding the influence of the
board on corporate goals is the board's power, in
practice, to influence management choices. Power is
a function of the information available to directors,
their independence from management, and the extent
to which directors speak for significant owners.
A final major influence on corporate goal setting
is the way in which senior management is rewarded,
notably its basis for compensation and promotion.
A management that is compensated heavily based on
current period accounting earnings, for example, will
set different goals than one compensated based on
market share. Similarly, a management that expects
to hold its position for a decade sets different goals
than one hoping to be promoted quickly or moved to
a position in another business unit or company.
corporate goals are centered on earning high returns
on investment or maximizing "shareholder value,"
measured by the highly imperfect indicator of current
stock price. While the prevailing legal interpretation
allows for long-term shareholder value to outweigh
short-term stock price in evaluating corporate decisions,
the burden of proof has seemed clearly to rest in
the opposite direction. Managements (and directors)
who sacrifice short-term stock price for long-term
shareholder value still run the risk of lawsuits,
while companies that maximize short-term stock price
at the expense of long-term shareholder value normally
In the United States, the board of directors holds
ultimate responsibility for corporate performance
but exerts relatively limited influence on corporate
goals or management actions. Nominees are selected
by the current board. The CEO is often the source
of ideas for new candidates and often exerts a strong
influence over the election process as well as the
ongoing operation of the board. This is partly because
most CEOs are also board chairmen (in 83 percent of
corporations surveyed by Lorsch and MacIver 1991).
Recent growth in the size of boards has also weakened
the power of directors by making discussion and decision
making in formal meetings extremely difficult (see
The composition of the board further enhances the
relative power of the CEO. Boards have come to be
dominated by outside directors who exert limited influence
on corporate goals, while board representation by
major owners, bankers, customers, and suppliers has
diminished. An estimated 74 percent of the directors
of Fortune 1000 companies are now outsiders with no
direct ties to the corporation, and 70 to 80 percent
are full-time CEOs of their own companies (Eaton 1990;
and Lorsch and MacIver 1991). Because employees, customers,
and suppliers are typically viewed as having interests
that conflict with the corporation they are rarely
represented on boards and thus have limited influence
on corporate goals.
Employee pension funds, which could serve to align
the interests of employees and owners or represent
employee views to management, are limited to holding
10 percent of their assets in the sponsoring firm.
Pension funds are also essentially prohibited from
holding seats on the board of directors. It is ironic
that employee pension funds have come to embody the
pressures of the external market even though they
could provide a valuable role in balancing stakeholder
The move to outside directors arose out of calls for
greater board objectivity. Yet lack of ties by the
director to the corporation limits the ability of
directors to absorb the vast amounts of information
required to understand a firm's internal operations.
Moreover, directors typically hold rather limited
ownership stakes. While the median aggregate holdings
of the board account for an estimated 3.6 percent
of equity, most directors have no shares at all or
only nominal holdings (Lorsch and MacIver 1991; Morck,
Shleifer, and Vishny 1988). In practice, then, neither
owners, lenders, directors, employees, customers,
nor suppliers exert direct influence on corporate
Thus, the dominant influence on corporate goals is
management, which interprets signals from the external
capital market (perhaps incorrectly) and which is
often subject to limited direct influence by either
boards or owners. The goals set by U.S. managements
are typically framed in terms of ROI (return on investment)
or enhancing stock price. Managers care about stock
prices because, among other things, they affect the
corporation's ability to raise new equity and its
vulnerability to control changes, which diminish their
power or eliminate their position.
As we have seen, U.S. managements are oriented toward
reporting high rates of return and responding to investor
signals about how to maintain high stock price. Table
1.1, which reports the comparative ranking of goals
in a sample of U.S. and Japanese companies, highlights
the primacy of current rate of return and stock price
among U.S. managements. In Japanese companies, earnings
are significant because they are necessary to fund
other priorities, but stock prices are essentially
irrelevant.The pressures imposed by corporate goals
have been exacerbated by a historical trend toward
decentralized management structures. These began to
proliferate as early as the 1950s, as wartime planning
and budgeting techniques were adopted by corporate
management and U.S. companies first reached huge scale
and complexity. These developments began distancing
senior management from the details of the business.
Comparisons of Japanese and U.S. Corporate Objectives:
Mean Importance Rating
introducing new products
introducing new products
Streamlining production and
of social image
of social image
Data from Kagawa, Nonaka, Sakakibara, and Okumura
Note: 3 = most important, 0 = least important
explosion of unrelated or loosely related diversification,
dating from the 1960s, both reflected and reinforced
Over time, information flow and top management involvement
in business unit management have fallen, and extreme
forms of decentralization involving little cross-business
unit interchange have spread. Corporate leadership
positions have come increasingly to be filled by nontechnical
executives, and tenure in senior management positions
seems to have decreased. With these changes, the view
has developed that general managers can run any business,
regardless of product line or technology. These organizational
changes have been supported by, and have contributed
to, an increased reliance on financial budgeting and
other management systems that use quantitative techniques
to evaluate the performance of business units and
to make investment decisions.
Comparative Perspective on the U.S. Problem
The cumulative and combined effects of the system
that has been described here are especially visible
in the comparison between U.S. investment behavior
and the behavior of our Japanese and German counterparts.
We may summarize the contrasts in the following ways.
U.S. system is less supportive of investment overall
because of its greater sensitivity to current returns
for most established companies, combined with corporate
goals that stress current stock price over long-term
The U.S. system favors those forms of investment
for which returns are most readily measurable, due
to the importance of financial returns and the limited
information available to investors and managers.
The U.S. system favors discrete, stand-alone investments
that generate leaps in position over ongoing investments
required to build capabilities, those whose payoffs
depend on complementary investments in other forms,
or those that create an option value for the future.
The U.S. system heavily favors acquisitions, which
involve assets that can be easily valued, over internal
development projects that are more difficult to
value and constitute a drag on current earnings.
The Japanese and German systems encourage aggressive
investment in established businesses to upgrade
capabilities and productivity. They also encourage
investment in intangibles and internal diversification
in order to redeploy personnel and secure the future
of the enterprise. This comes at the cost, however,
of a tendency to overinvest in capacity, to proliferate
products, and to maintain unprofitable businesses
indefinitely.|7 Especially in Japan, managers have
discretion to make poor decisions as long as results
Managers also have less incentive for strong individual
performance in some respects, and these systems
are prone to overemployment and greater difficulty
in weeding out poorly performing employees. There
is also an inability to rapidly enter emerging fields,
especially via start-ups. However, unlike the U.S.
firms in mature industries that invest their excessive
cash in the wrong areas, Japanese firms benefit
from the forces in the external and internal markets
that tend to direct excess capital into the areas
more aligned with long-term value. The benefits
from overinvestment are thus higher.
the U.S. system comes closer to optimizing short-term
private returns, the Japanese and German systems appear
to come closer to optimizing long-term private and
social returns. They appear better able to address
the investment spillovers within the firm. Goals that
stress market position and corporate perpetuity and
management processes involving greater top management
information and cross-unit interchange seem better
able to encourage complementary, shared, and option
value-creating investments. Their greater focus on
long-term corporate position, and an ownership structure
and governance process that incorporates the interests
of employees, suppliers, customers, and the local
community allow the Japanese and German economies
to better capture the social benefits that can be
created by private investment.
U.S. system for allocating investment capital has
potent disadvantages, yet the Japanese and German
systems are not ideal in every respect. There are
important trade-offs among national systems. The U.S.
system is good at reallocating capital among sectors,
funding emerging fields, shifting resources out of
"unprofitable" industries, and achieving
high private returns each period, as measured by the
United States' higher corporate returns on investment
This responsiveness and flexibility is achieved at
the price of failing to invest enough to secure competitive
positions in existing businesses and investing in
the wrong forms. The U.S. system discourages investment
in many companies and industries, particularly in
intangible assets and in the linked and complementary
investments that are needed to sustain and upgrade
competitive capability. It is skewed toward acquisitions
as opposed to building businesses internally, which
leads to highly consolidated industries in which competitive
rivalry is threatened. It also fosters overinvestment
in profitable, mature sectors with few attractive
The Case for Reform
Regulatory Influences on the U.S. System
a considerable degree, the U.S. investment problem
is our own creation. Many of the changes that have
occurred and the trade-offs now present in the U.S.
system have developed out of the regulatory regime
established in the 1930s to deal with the perceived
abuses occurring in financial markets at that time.
In the intervening years, a long series of piecemeal
regulatory choices have been made that have resulted
in the U.S. investment system in its current form.
great majority of the regulatory choices underlying
the U.S. system were enacted to address goals that
were often laudable but different from corporate investment
behavior. The first principle, dating back to the
1930s or even before, was to avoid the concentration
of economic power. The alleged abuses of large, dominant
owners of companies were seen as an important cause
of the Depression. U.S. regulators sought to limit
the power of financial institutions, in particular,
to affect stock prices or to manipulate corporate
A second and related principle was to separate the
investment and control functions. The view emerged
that there was a conflict of interest between the
role of an investment manager and the role of a controlling
owner. Controlling owners could take actions that
could hurt individual shareholders such as dumping
worthless shares into their managed investment portfolios.
Similarly, exercising influence as an owner through
such vehicles as a role on the board of directors
was seen as compromising the objectivity of an investment
A third guiding principle of U.S. regulation has been
equal treatment of all investors, big and small, by
providing for equal disclosure of material information
and protection against abuses by insiders. Closely
related to equal treatment was a fourth principle:
to protect small investors, pension holders,
insurance policyholders, and bank depositors.
principles guiding U.S. regulation address some legitimate
and commendable purposes and have achieved the goal
of keeping abuses to a bare minimum. The result is
public markets that are superior in some important
respects to those in Japan and Germany. However, the
cumulative pattern of regulation has had unintended
consequences for investment behavior in the U.S. economy.
A number of laws and regulations have directly or
indirectly ensured that U.S. institutional agents
hold small stakes in companies and that their holdings
are widely diversified. Mutual funds, for example,
are discouraged by tax incentives for diversification
in the Internal Revenue Code and by reporting requirements
under the Investment Company Act, from owning more
than 10 percent of the stock of any firm. The fiduciary
responsibility of pension fund and trust fund managers
requires "prudent" diversification. In practice,
that managers hold small stakes in dozens if not hundreds
of companies. State law governing life insurance companies
also requires significant diversification.
By stimulating excessive diversification and the holding
of many small stakes in companies, the U.S. system
has encouraged frequent trading and heightened the
influence of accounting earnings on buy/sell choices.
This, in turn, made timely disclosure of event information
crucial and insider trading a major concern, compared
to a system in which share ownership was more stable.
Disclosure rules prohibit significant owners from
becoming knowledgeable "insiders," while
limits on board membership bar them from direct access
to in-depth company information. While there is a
great deal of information that leads almost instantaneously
to significant swings in share prices, the information
is of the wrong type to match capital with those companies
with the best long-term prospects. The ultimate absurdity
is that U.S. institutions are driven to index funds,
which are information free, or to simple value proxy
investing involving little or no fundamental information
or concern about long-term company prospects as the
best available investment alternatives.
In most cases, the abuses that most concerned regulators
occurred in situations where there was unequal power
and goals that were not aligned. The more powerful
interest then took advantage of the other. Rather
than better align the goals, however, regulators sought
to equalize the power in the system by simply eliminating
powerful owners or severely restricting their activities.
Ironically, the result was that corporate managers
became relatively free from direct influence or oversight
by major owners, while they were still reliant on
capital from owners whose goals increasingly diverged
from those of the corporation.
The record shows a near total failure by legislators
from the 1930s to the 1980s to consider the effects
of regulation on corporate performance. Moreover,
each successive area of regulation often led to more
regulation. Due to the tendency toward mutual consistency,
regulations in one area can also shape other parts
of the system. Similarly, inconsistent regulations
of different parts of the system can produce conflicts
and frustration. A common outcome of such conflicts
is further regulation.
to Reform the System
Improving the U.S. system for capital allocation will
require complementary changes in public policy, in
the behavior of institutional investors, and in the
practices of management. To be most effective, an
array of changes must be implemented simultaneously;
changes in one part of the system that are not balanced
with changes in other parts can be counterproductive.
The ideal system is one in which the goals of owners
and the agents who represent them are aligned with
those of corporations and of society as a whole. A
better alignment of goals would be the most important
step forward and would itself lead to beneficial changes
elsewhere. We need a system in which more and different
information is used to guide valuation and investment
decisions. More aligned goals and better information
must drive a process by which constructive intervention
occurs at all levels when behavior departs from the
long-term best interests of the corporation. Finally,
the system must be modified to better align private
shareholder returns and those of the economy as a
whole. What is needed, in many respects, is a reexamination
of our entire capital market paradigm.
A more supportive macroeconomic environment, which
provides the context in which all corporate investment
takes place, will provide a foundation for the other
systemic changes needed. Increasing the stability
of this environment and enlarging the pool of savings
will reduce risk premiums and lower the cost of capital.
Beyond the macro environment, reform is needed in
the broad areas of (1) ownership, (2) goals, and (3)
information. In the following sections, we will translate
these areas into specific directions with implications
for policymakers, corporate management, and institutional
The directions for policy reform rest on principles
that differ markedly from those that have defined
the regulatory framework of the traditional U.S. system
of capital allocation. Rather than avoid abuses by
restricting the activities of the largest capital
providers and large corporate owners, corporate ownership
can be broadened while the goals of capital providers,
corporations, managers, employees, and society are
better aligned. Capital providers become knowledgeable
and constructive participants rather than adversaries.
Abuses can be prevented by modifying incentives and
eliminating unneeded regulatory guidelines rather
than resorting to regulatory constraints that carry
Stated most boldly, our research suggests the need
to reexamine much of what constitutes the U.S. system
of management, with its extreme approach to managing
decentralization, its limited flow of information,
its heavy use of certain types of incentive compensation
systems, and its reliance on financial control and
quantitative capital budgeting processes.
While the U.S. system is partly the result of regulation,
there are positive steps that can be taken by institutions
without the need for public policy changes. First
and foremost, institutions must begin to understand
why managements view them as adversaries. They must
understand the subtle consequences of their monitoring
and valuation practices on corporate investment behavior.
They must also recognize that greater influence over
management will come only at the price of less flexibility,
less rapid trading, and the need for greater knowledge
of and concern with company fundamentals.
Expand True Ownership throughout the System
The current concept of ownership in the U.S. system
is too limited and restricted largely to outside shareholders.
While outside owners should be encouraged to hold
larger stakes and to take a more active and constructive
role in companies, ownership should also be expanded
to include directors, managers, employees, and even
customers and suppliers. Expanded ownership will foster
commonality of interest and help make investors and
managers more aware of the value of investment spillovers
that strengthen firms, benefit employees, and enhance
the economy as a whole. A number of policy changes
could shift the pattern of wnership to favor appropriate
investment and better address externalities, for example:
restrictions on share ownership.
The regulations that artificially restrict the ability
of investors to hold significant corporate stakes
should be reexamined, as should restrictions on
joint ownership of debt and equity. Limits on significant
holdings should be eased, diversification rules
relaxed, and fiduciary guidelines governing institutional
investors modified to better reflect the true risk
to owners (it can be shown, for example, that the
value of diversification can be gained by holding
relatively few stocks, certainly many fewer than
the 100, 500, or 2,000 that are now common).|8
tax barriers to holding significant private ownership
Estate tax laws need to be reexamined to strike
a better balance between the need to equitably collect
estate taxes and the ability of significant private
owners to maintain their ownership stakes. Ways
of structuring estate tax rules to allow their payment
over some extended period, where illiquid or hard-to-value
assets are involved, would be desirable.
long-term owners and give them a direct voice in
Perhaps the most basic weakness in the U.S. system
is transient ownership, in which institutional agents
are drawn to current earnings, unwilling to invest
in understanding the fundamental prospects of companies,
and unable and unwilling to work with companies
to build long-term earning power. The long-term
interests of companies would be best served by having
a smaller number of long-term or near permanent
owners, whose goals are better aligned with those
of the corporation. This does not necessarily mean
taking the company private but could involve a hybrid
structure of "private" and public ownership.
Ideally, the controlling stake would be in the hands
of a relatively few long-term owners,
though shares were publicly traded to allow access
to the public markets when
conditions were favorable. Some owners might represent
syndicates of other, smaller, long-term owners.
return for a commitment to long-term ownership
and to becoming fully informed about the company
must come a restructuring of the role of owners
in governance. Long-term owners must have insider
status, full access to information, influence
with management, and seats on the board. The board,
consisting primarily of owners along with suppliers,
customers, and others highly knowledgeable about
the firm's business, should be both influential
Nominate significant owners, customers, suppliers,
employees, and community representatives to the
board of directors.
As described earlier, such directors are more likely
to have the company's long-term interest at heart
and to encourage management to make the investments
required to ensure long-term competitive position.
long-term employee ownership.
Ownership by employees is desirable for a variety
of reasons, provided that employee owners are long-term
rather than transient owners. Employees' goals as
owners will tend to be aligned with the long-term
health of the corporation, and employee ownership
is likely to internalize some of the externalities
in investment choices by heightening the pressures
for investment in human capital. Taxes and other
regulations should facilitate and encourage employee
stock ownership. Currently, companies can offer
shares to employees at a discount of up to 15 percent
of market price with no earnings impact, and such
incentives should be maintained or increased. Rules
that allow low-cost issuance of new shares for employee
ownership should be enacted. To qualify for such
fiscal advantages, however, employee stock ownership
plans should be required to restrict the sale of
affected employee shares for five years except in
cases of genuine hardship and to limit the proportion
of holdings that can be sold in a given year.
Better Align the Goals of Capital Providers, Corporations,
Managers, Employees, Customers, Suppliers, and Society
More ownership per se will not be sufficient if the
goals of owners, corporations, and others are not
aligned with each other and with the maximization
of long-term corporate value. It is possible to create
a system of incentives and to alter rules in a way
that helps align the goals of all constituencies.
Since the goals of agents will inevitably reflect
those of owners, we must address owner goals directly.
The single most powerful and practical tool for modifying
owner/agent goals is establishing a significant incentive
for making long-term investments in corporate equity.
The governing principle behind this proposal is to
fundamentally change the system by changing the concept
of ownership and the approach to valuing companies,
while at the same time encouraging the form of investment
where the externalities are greatest.
The current debate over capital gains, focused on
encouraging investment and raising short-term tax
revenue, misses the point. Currently, ordinary income
and capital gains are treated as equivalent, and the
debate over capital gains incentives is stalled. Our
proposal is to restrict the incentive to equity investments
in operating companies. The incentive would not apply
to capital gains from bond appreciation or real estate
appreciation, from investments in nonoperating companies
holding real estate, or from other financial assets.|9
The long-term equity investment incentive would require
a minimum five-year holding period, with lower tax
rates for even longer holdings. Ideally, capital gains
would also be indexed for inflation. The equity investment
incentive would be prospective, applying only to new
investments and new gains.
mechanisms for affecting the goals of owners and lenders
include extension of the long-term equity investment
incentive to currently untaxed investors such as pension
funds and eliminating restrictions on joint ownership
of debt and equity.|10 It would also be desirable
to reduce the extent of explicit and implicit subsidies
for investment in real estate. The positive externalities
involved in real estate investment do not seem to
justify the disproportionate level of incentives compared
to investments in corporate equity, R&D, and training.
Shifts in corporate goals will need to accompany regulatory
changes such as those just suggested if they are to
be effective. Existing corporation law identifies
long-term shareholder value as the appropriate corporate
goal. Stakeholder laws, which explicitly provide for
the interests of other parties such as employees or
the local community in corporate goals, are a less-than-ideal
solution to this problem. Stakeholder interests are
hard to clearly define, prone to overemphasis, and
subject to wide discretion. The granting of director
discretion to consider stakeholders' interest (implicitly,
at the expense of shareholders) without those stakeholders
for corporate performance having responsibility serves
to further isolate boards from owners. A far better
solution is to explicitly identify long-term shareholder
value as the corporate goal and shift the burden of
proof on directors and managers to explain to owners
or other major constituents why decisions build long-term
value. This would be accomplished by modification
of corporation laws designed explicitly to reduce
the threat of litigation. The interest of
shareholders, employees, the local community, and
other stakeholders is far closer, if not identical,
in the long run than in the short run. Improved aligning
of the interests of owners and corporations, combined
with the other changes we have suggested, can go a
long way toward properly addressing the problem that
stakeholder laws reflect.
Improvements in the internal capital allocation and
investment monitoring process must primarily be the
responsibility of management. However, some incentives
designed to better align private and social returns
on selected forms of investment would be desirable.
In particular, regulation can provide investment incentives
for R&D and training. Such forms of investment
are particularly subject to externalities that make
the optimal private rate of spending less than for
society. Making the existing R&D tax credit permanent
and creating a parallel tax incentive for training
investments should take on high priority.
need for traditional investment tax credits, on the
other hand, is more problematic. Investment tax credits
are expensive and are subject to political distortions.
The U.S. system of capital allocation is less biased
against investment in hard assets, and the externalities
involved in such investments seem more limited. Public
resources would seem better spent in funding the long-term
equity incentive, which will shift the entire valuation
system to encourage investment and the funding of
permanent incentives for R&D and training.
U.S. compensation systems need to move in the direction
of linking pay more closely with long-term company
prosperity and to actions that improve it. Performance
awards should be based not only on rate of return
for the year but on the extent to which the company's
competitive position has improved (or weakened) based
on objective measures. Stock options should be modified
to include long (more than five-year) vesting periods
and constraints on the number of shares that can be
liquidated at one time. Otherwise, even some well-meaning
managers will manage the stock price rather than build
Another way to align the goals of management with
the long-term health of the corporation is to move
away from unrelated diversification. Unrelated or
loosely related diversification not only wastes capital
but also exacerbates the management biases that we
have described. Concentrating on one or a few core
fields and investing heavily to achieve a unique position
in each of them is the only way to build highly competitive
Institutional investors are a special case in that,
as we have seen, they control the major part of the
external capital market in the United States. The
U.S. system of capital allocation creates perverse
outcomes for institutional investors, especially pension
funds. Such institutions should be the ideal long-term
investors. Instead, we have the paradoxical situation
in which many institutions, especially pension funds,
are entrusted with funds for extremely long periods,
yet trade actively. Institutions incur substantial
transactions costs, yet most underperform the market.
Many have been driven to index funds. Because of the
widespread holdings of institutional agents, a gain
on the sale of one stock comes as a loss on another
stock. Thus, the only way for institutions to improve
their overall performance is to improve the earning
power of U.S. companies, which will increase their
aggregate value. Society also has a large stake in
creating a system where the "winning" institutions
are those that are better at rewarding and directing
capital to companies with the best long-term prospects
rather than those whose earnings will improve next
Institutions can take the lead in moving toward the
the size of stakes
Reduce turnover and transactions costs
More carefully select companies based on fundamental
Encourage changes in agent measurement and evaluation
systems to reflect long-term investment performance
Transform interactions with management to productive,
advisory discussions. Create special funds to test
these new investment approaches
Support systemic public policy changes
might find it easier to make such changes if, as a
first step, they were to consider creating special
funds earmarked for long-term investing in significant
stakes in companies who agree to give major owners
a greater influence in management. Given existing
rules, establishing such funds might require agreements
modifying the funds' fiduciary responsibilities. Such
funds would be structured to provide liquidity without
the need to sell positions through mechanisms by which
existing investors or new investors could buy (at
the current market price) the holdings of those investors
needing to generate funds.
There are positive changes underway in some of these
areas that can be built upon. Even CalPERS, for example,
is attempting to reduce its number of portfolio companies,
from over 2,000 to between 700 and 800 (White 1991;
Lorsch and MacIver 1991). The more institutions that
modify their approach to investing, the more the fruits
of a shift to committed long-term investing will become
a self-fulfilling prophecy, because enough funds will
seek out the most competitive companies to drive market
prices. Current earnings will begin to have less and
less of an impact on share prices. Stock prices could
become less volatile. The transactions cost savings
alone of this approach will provide a head start in
registering better investment performance.
Improve the Information Used in Decision Making
Even if goals are better aligned, the quality of information
used to allocate capital throughout the system will
affect investment choices. We must expand access by
both investors and managers to information that better
reflects true corporate performance. While some of
the needed changes in this area can be initiated via
regulation, much of it will depend upon corporations
recognizing and correcting counterproductive organizational
structures. For example, the mode of managing decentralization
in place in many U.S. companies must be overhauled
to provide greater information flow and to better
align it with the imperatives of competitive advantage.
The problem is not that decentralization is bad per
se but that it has been inappropriately managed, partly
because of excessive corporate diversification.
What is needed instead is a system that recognizes
strategically distinct businesses as the proper unit
of management but manages them differently. Senior
managers at the corporate level must have a substantive
understanding of both the technology and the industry.
Top management must be directly and personally involved
in all significant decisions, especially investments.
There must be extensive consultation and coordination
with employees and among related business units. Information
must be exchanged both vertically and horizontally.
Opportunities to share functions and expertise among
units should be pursued aggressively because they
leverage tangible and intangible investments. Incentives
must be changed to promote the internalization of
such spillovers within the company.
Such a system would shift measurement and control
away from solely financial results, raise senior management
confidence in understanding complex investment choices,
and better capture complementarities among discrete
investment options. A new philosophy of management
control must be instituted, based as much or more
on the company's extended balance sheet as on its
income statement. A company's extended balance sheet
measures the assets that constitute its competitive
position. Financial measures of investment returns
should be combined with measures of competitive position
such as market share, customer satisfaction, and technological
capabilities. A more appropriate control system must
include the following elements.
definition of assets
Measurement of asset quality and productivity in
addition to quantity
Relative instead of absolute measures.
Move to universal investment budgeting
Evaluation of investment programs instead of discrete
Unified treatment of all forms of investment
Separate the determination of required asset position
from evaluation of the means of achieving it.
Other constructive changes in corporate behavior would
include the following points.
accounting rules so that earnings better reflect corporate
The accounting profession, led by the SEC if necessary,
should create new standards for accounting for intangible
assets. R&D and other long-term intangible investments
should be capitalized under rules that require disclosed
write-offs of worthless investments as part of the
auditing process. While there will inevitably be some
abuses, as there are under the current system, the
benefits in terms of improved valuation and the resulting
shifts in corporate behavior should outweigh them.
Expand public disclosure to reduce the cost of
assessing true corporate value.
Accounting earnings, even if modified to better account
for investments in intangibles, still fail to provide
a measure of true long-term corporate value. Value
resides in a company's activities, its stock of scientific
and technical knowledge, its skill base, its reputation
with various constituencies, and its market position.
Disclosure should be extended in these areas in order
to improve the information available for investment
choices and to lower its cost as well as to help offset
the biases against intangible investments.
Move to universal investment budgeting.
Capital budgeting systems were designed not to evaluate
the strategic investments required to remain competitive
in the business but to decide among discretionary
investment options. Discounted cash flow methodology
requires that the benefits and costs of investments
be quantified as cash inflows or outflows. As Baldwin
and Clark (1992) suggest, however, the option value
of investments is ignored.
disclosure of "inside" information to significant
long-term owners under rules that bar trading on it.
Beyond expanded public disclosure, institutions and
other owners who have held a significant ownership
stake (e.g., 1 percent or more) for a qualifying period
(e.g., one year) should have access to more complete
information about company prospects than that which
is disclosed publicly, provided that such information
is not disclosed to third parties.
Promise of Reform
The U.S. system is already experiencing changes in
several areas. Institutional investors have begun,
in some cases, to shift from influencing management
through indirect proxy proposals to raising important
issues through formal discussions. Boards are also
beginning to take a more active role in monitoring
poorly performing managements. In the internal market,
some firms are developing closer relationships with
customers, suppliers, and employees, while others
are encouraging greater information flow through increased
cross-functional training. Yet the underlying causes
of our investment problem, particularly the goals
and information that guide the decisions of investors,
directors, and managers, remain the same.
The changes that have been suggested here will work
to increase true ownership in the economy; better
align the goals of U.S. shareholders, corporations,
managers, employees, and society; improve the information
used in investment decisions; more effectively scrutinize
managements based on criteria more appropriate to
competitiveness; and make internal management processes
more consistent with the true sources of competitive
advantage. Changes in critical areas, such as ownership
patterns and owner goals, will trigger constructive
changes elsewhere in the system. The same changes
will not only encourage investment in more appropriate
forms in many U.S. companies but will also work to
reduce wasted investment in those companies, and those
forms, that are prone to it.
If progress can be made on these fronts, it will not
only reduce the disadvantages of the U.S. system but
can result in a system that is superior to that in
Japan and Germany. A reformed U.S. system would be
more flexible, more responsive, and even better informed
in allocating capital than those in Japan and Germany.
Investors in a reformed U.S. system would be long-term
owners but not necessarily permanent ones. This would
provide more flexibility than exists in Japan or Germany
to withdraw capital if long-term prospects are genuinely
unattractive. In a reformed U.S. system, the substantial
number of sophisticated U.S. investors making independent
choices would redirect their valuation methods and
make investment choices that would arguably be better
informed than those in Japan and Germany. A reformed
U.S. system would also produce more careful monitoring
of management, and more pressure on poorly
performing managements, than exists in Japan or Germany.
A reformed U.S. system, with its already higher levels
of disclosure and transparency, would also be fairer
to all shareholders than the Japanese and German systems.
Altering the U.S. system of capital allocation is
complicated by the fact that systemic change will
be necessary to make a real difference. It will also
be complicated by the need for all the major constituencies
to sacrifice some of their narrow self-interests in
the pursuit of a more satisfying overall system. Yet
we must avoid the tendency to tinker at the margin.
The widespread concern and dissatisfaction with the
status quo suggests that systemic reform may be possible.
The gains will accrue not only to investors and firms
but to the rate of long-term productivity growth,
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Porter, M. E. 1990.The Competitive Advantage of
Nations. New York: The Free Press.
Porter, M. E. 1992. Capital Choices: Changing
the Way America Invests in Industry Washington,
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A number of authors have recognized the growing importance
of intangible investments. See, for example, Itami
1987, Curtis 1990, and Baldwin and Clark 1992.
2. For further discussion of these issues, see Ghemawat
1991; Baldwin and Clark 1992; and Seckler, in this
volume, chap. 5.
3. The supporting literature is extensive. See, for
example, Summers 1990 and Mansfield 1991.
4. The only area of human resources in which the United
States may invest as much as or more than other leading
nations is in public education, although here there
are significant concerns about quality. In public
education, however, the private sector is not making
the investment choices.
5. See table 1 in Froot, Perold, and Stein 1992, which
is slightly higher than estimates by Lorsch and MacIver
(1991) who find that 1983 holding periods were 1.6
years for pension funds and 1.3 years for mutual funds.
6. Morck, Shleifer, and Vishny (1990) find that "The
source of bust-up gains in the 1980s is the reversal
of the unrelated diversification of the 1960s and
the 1970s. Hostile bust-up takeovers simply undo past
7. Kester (1992) notes that the Japanese system of
governance has faults in excess human resources, excessive
product proliferation, overinvestment in declining
businesses, unrelated diversification beyond organizational
capabilities, and mismanagement of huge corporate
excess cash balances.
8. It is important to note that encouraging greater
concentration of ownership in individual corporations
will not result in greater concentration of wealth
in the economy as a whole.