Capital question haunts US boardrooms

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The Independent Online
WHEN Michael Porter speaks, corporate America listens. Not only is Mr Porter one of the most sought-after talents at the Harvard Business School, he is also a 'big picture' man, intent on long-term goals and the overall competitiveness of countries and businesses. Small wonder, then, that Mr Porter's forthcoming book, Capital Choices: Changing the Way America Invests in Industry, is a bestseller before it has been published.

The summary and sample chapters that have been circulating through US boardrooms are revolutionary, as is the thrust of the entire study - the product of two years' research by 25 of the best academic minds in America.

Mr Porter, well known for his earlier work, The Competitive Advantages of Nations, has lifted the team approach to social science research to new heights. It is possible to track the specifics of his recommended 'holistic approach' to transforming the US system of allocating investment capital - a change that is imperative for American companies to regain their competitive edge.

Competitiveness is now coursing through US political life much as national security did at the height of the Cold War. Mr Porter's work was jointly sponsored with Harvard by the Council on Competitiveness, a private-sector group of leading figures in industry, finance, labour and academia.

The premiss is that the US system - which has been eagerly embraced by newly privatising societies - is no longer functioning properly.

Mr Porter's study focuses on the narrower issue of investment capital, but it broadly embraces the whole question of the interplay between private sector and government. The main conclusion, of course, is that the system is driven by an acute case of short-termism and needs to be fixed. But Mr Porter is proposing drastic surgery, not mere palliatives such as abolishing quarterly company reports.

Crudely put, Mr Porter finds that American companies either underinvest or invest too much in the wrong things, a failing that has as much to do with the management of companies as their ownership.

Public policy decisions over the past two decades - particularly the often perverse tax incentives shaped by special interests - have exacerbated the problems. Thus the analysis by Mr Porter's group of two specific markets - the external capital market for equity and debt, and the internal corporate market, in which funds are allocated to specific projects - reveals clear, negative biases. In the US system, unlike its German and Japanese counterparts, these two markets have been shaped by a culture that fights accumulation of power and regulates against abuse, rather than aiming to achieve long- term efficiency. For mature industries, notably steel and cars, the results in a newly integrated global economy are disastrous.

One key recommendation in the Porter group study that is likely to find its way into legislation is a vastly enhanced role for pension funds.

In dissecting US investment, Porter differentiated between fluid capital and dedicated capital and found that US companies rely increasingly on a transient non-individual ownership base. These owners - pensions, mutual funds and others - increased their holdings from 8 per cent of total equity in 1950 to 60 per cent by 1990.

Their performance is measured by quarterly or annual appreciation compared to stock indices, so they seek short-term appreciation - they hold shares for an average of only 1.9 years. Due to legal constraints on concentrated ownership and other fiduciary requirements favouring diversification, their portfolios include small stakes in hundreds of companies. Corporate management, in return, is driven by the need to satisfy these investors.

This must change if the US system is to receive a larger injection of dedicated capital that will stay the course, encouraging investment in essential intangibles such as worker re-training. The Porter group thus recommends amending laws to lift quantititive restrictions, allowing institutional investors to have large stakes, to sit on corporate boards, and to work with management to achieve long- term competitiveness. Pensions, after all, are in the game for the long haul.

Big-scale pension investment in individual companies is just one prong of a broader scheme to expand 'true' ownership throughout the US system. Giving workers a vital stake is another. If these longer-term horizons are added to what America does best - find flexible ways to fund new things and shift resources quickly out of the unprofitable - Mr Porter says, the US could again have the best system in the world.