Strategic Management and Financial Markets

In a 1992 article, Porter argues that the U.S. capital investment system is failing a wide range of constituencies including firms' investors, managers, and employees, because of its focus on short term performance. In contrast, in Germany and Japan many shareholders have large stakes which are held for a long time. The U.S. advantage appears to be at providing finance for emerging fields and reallocating capital among sectors. Is the U.S. system in fact harmful to long-term competitiveness? The U.S. system relies much more heavily on stock markets than do Germany and Japan. If there were complete agreement on and information about how companies should and are run, the allocation of capital would be straight-forward. In the "open" U.S. style system many investors have different opinions on best practices; stock prices reflect this diversity. In a "closed" German style system a few bank employees decide whether loans will be granted. This system works well in mature competitive industries where there is wide agreement on how firms should be managed, but does not work as well when opinions differ. Allen argues in a previous paper that differences in financial systems lead to very different dynamic properties for capital allocation systems. The type of financial system which is suited to traditional industries where there is consensus is very different to dynamic industries where there is no widely agreed on basis for evaluating managerial action. Banks are suited to traditional industries, while stock markets are suited to dynamic industries. The author suggests the predominance of institutional investors and transient ownership in the U.S. financial system are not necessarily the cause of the lack of competitiveness of U.S. firms. Thus, if it is not the financial system that is failing the U.S., why are U.S. companies falling behind international competitors? Porter says U.S. management practices have not kept pace with a changing world; Germany and Japan have adjusted much better. The issue is far more complex. The difference in growth rates between the countries is one fact that receives little attention and yet is quite important. In the last four decades, both Japan and Germany out-paced the U.S., with Germany slowing down in the 1980s. This means that incentives provided through annual raises differ significantly across the countries. Although senior U.S. managers have large financial incentives to work hard, middle level managers have been less fortunate. The impact is seen dramatically in Germany, where German firms did better than U.S. firms during the earlier periods, but not during periods of more similar growth. The research suggests that international industrial leadership will be cyclical. During stages where incentives and growth reinforce each other, a country starting from behind will be able to overtake leading countries. Eventually the process will be reversed and countries that were formerly leading will be able to start from a readjusted low level and have a burst of fast growth that will once again allow them to take the lead.