By Rens Edwards

During the colonial era, Europeans would typically create two kinds of states in countries they invaded, depending on how useful that country was. In countries in which they saw a future for themselves, inclusive states appeared. Inclusiveness meant that more development-minded institutions were created. Extractive states did not provide much protection for things such as private property as its goal was to transfer as many resources as possible from the colonized to the colonizer. The latter occurred in countries where colonizers did not stay permanently.  

The idea of inclusive versus extractive institutions can be extended to the business world. In the business model, the board of directors function as the colonizers and the rest of the employees and shareholders as the colonized. Executives of a business have two options when managing the company. Either, they can choose for a short-term focus or they can pursue a long-term focus. The short-term (extractive) focus involves taking on risky projects that cause high earnings for the near future. This looks good on paper, as earning expectations are met and executives subsequently receive higher bonuses. However, this focus is detrimental to the long-term (inclusive) value of the company, because these companies invest less in research or marketing.

The main reason why executives choose the short-term focus, relates to their compensation. The higher the earnings in a given period, the higher the executive compensation. As a solution, companies should separate executive compensation from the company’s earnings. Otherwise, we see a trend where “elites (executives) that have prospered from inclusive systems can be tempted to pull up the ladder they climbed to the top.”

Similar to the depletion of resources in extractive states during colonialism, companies that become extractive will bleed out financially in no time.