Time Horizons and Technology Investments (1992) / Chapter Skim
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4 Time Horizons and Cost of Capital
4 Time Horizons and Cost of Capital
Pages 43-58
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From page 43... ...
High U.S. capital costs shorten the time horizons of investors, so do the pressures exerted on companies by the stock market, particularly by institutional investors and takeover specialists.
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From page 44... ...
High national capital costs (relative either to capital costs in other nations or to different times in the same nation) will dampen virtually all investment in assets promising future returns and lead to slower rates of national economic growth.
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From page 45... ...
The policy arguments relating technological advance and financial markets have centered on ways to lengthen the time frame of investments by providing lower taxes on investments held for longer periods (e.g., lowering capital gains taxes on investments held for long periods of time) ; reducing the cost of capital by reducing government borrowing (i.e., deficit reduction)
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From page 46... ...
Although this study does not take an international comparative approach in other matters it addresses, the committee judged the issue of international capital cost differentials to be to so much a part of the current debate over the role of time horizons in competitiveness that it deserved attention. The section is also useful in that it develops several explanations about the ways in which economic and financial market parameters affect company time horizons.
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From page 47... ...
In general, institutions have been most aggressive with stockholder resolutions, commonly pursuing a social agenda divestiture of investments in South African companies, environmental practices, and reducing foreign 4It is worth noting that institutional investors with short time horizons are often created by the same corporate managers who feel they suffer from the short-term orientation of financial markets. The orientation of some institutional investors toward quarterly performance is, in part, a reflection of the short-term orientation of boards of directors and executive managers of nonfinancial companies who want maximum return at all times in their own pension funds and often insist on measuring corporate pension fund managers on a year-to-year basis.
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From page 48... ...
CALPERS garnered attention for a role it played in suggesting and supporting directors for a distressed company and, most recently, for refusing to reelect a board of directors as a protest against large compensation packages for senior management. Is including institutional investors in the governance of an organization better or worse than relegating their influence to the proxy mechanisms?
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From page 49... ...
How do the typical sources of finance for these activities affect the time horizons of operations? What is the effectiveness of government programs, such as Small Business Innovation Research, aimed at supporting technological start-ups?
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From page 50... ...
Information about prospective returns creates financial markets, and governments have long been in the business of regulating basic financial information to certain standards of reliability in the United States, individual states took the lead in such regulation, and the Securities and Exchange Commission was established in 1934. Standard financial information about a company, however, does not begin to provide the information necessary to judge the likely impact of a new long-term corporate research program or a systematic (and probably expensive)
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From page 51... ...
Time Horizons, Technology Investments, and Ownership Structures Additionally, the ownership structure of the firm may have a direct impact on the cost of capital to the firm; if the firm is private or a large block of the stock is held by a single investor, a family, or a trust, the firm can be provided with more stability than a firm whose stock is virtually all traded openly. Family-owned companies have the reputation, at least in the first generation, of being able to make long-term investments the investors are willing to be more patient than a firm whose stock is traded in large blocks by institutional investors.
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From page 52... ...
Too many companies limit their information sharing with stockholders when there is bad news and, consequently, investors are left with an increased level of discomfort about the investment and will eventually sell their shares. In most cases, managers have many opportunities to affect both the stockholder profile and the investment community's perception of the organization with the effect of lowering a company's cost of capital and thereby providing management with the opportunity to lengthen investment time horizons.
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From page 53... ...
As a result, market clearing rates for debt are nearly equal in the United States and major industrial competitor countries (Hatsopoulos, 19911. This has focused increasing attention on the cost of equity and the impact of corporate financial structures and national financial market structures (both of which vary considerably among nations)
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From page 54... ...
Clearly, in this situation a company would be extremely unlikely to have a long-term perspective; time horizons would be driven to the very short term. It is beyond the committee's scope to settle the various uncertainties about the existence and magnitude of national differences in costs of capital or the impact of different types of corporate financial structure and restructuring on long-term investment.
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From page 55... ...
capital gains taxation (or a rate that decreases substantially as the investment is held longer) would reduce the pretax return demanded, reduce the cost of equity capital, and lengthen time horizons.
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From page 56... ...
Reduction in this double tax wedge between before- and after-tax rates of return would lower the cost of equity capital in the United States. Proposals to eliminate double taxation or to mitigate its impact on time horizons include (a)
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From page 57... ...
The growth of an institutionalized market for corporate control has driven dramatic change in the character and pace of corporate restructuring and is changing the relationships among boards of directors, top corporate management, and institutional investors. Even in the context of these strong trends in capital markets, corporate senior managers and boards of directors continue to be able to influence both the structure of company ownership and the way in which markets perceive the firm's potential as an investment opportunity.
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From page 58... ...
The committee recommends that the federal government move to allow longer investment time horizons for U.S. corporations through tax policy changes designed to reduce the pretax cost of equity capital.
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