A long look at short-termism

That is the title of a working study from Credit Suisse (pdf), here is one excerpt:

The problem is that short-termism is very difficult to prove. As we will see, many of the common perceived symptoms of short-termism don’t hold up to scrutiny, and there are some legitimate reasons for the shortening of time horizons. While there remains plenty of room for improvement, especially when it comes to incentives, the issue of short-termism deserves more care than it has received in the popular discourse. With little exception, the debate appears to be very one-sided.

Here is another good bit of many:

Were compensation the simple root of the problem, then correction through regulation or other market forces would be relatively straightforward. But a link between pay and termism is difficult to establish. Academic research shows that CEO pay has closely followed the size of the firms in the economy independent of the form of remuneration. Further, executive compensation has moved toward long term incentives, boards of directors are more independent than in the past, and governance committees are “nearly universal.” Reviewing the challenges of conclusively demonstrating short-termism, one scholar wrote, “[I am] aware of no empirical evidence establishing that executive pay term is inadequately focused on long-term performance from either a shareholder or societal perspective, systematically.”

And:

To summarize, a proper test of short-termism should address the micro-macro problem by relying on the outcome of the market pricing process rather than the views of individuals. While many constituents feel the market is short-term oriented—a feeling that has been expressed through the decades—asset prices don’t support this sense.

In fact there is a good deal of evidence that the sectors which require the most long-term attention attract investors and boards who understand that need.  Here is my previous post on this issue.

For the pointer I thank Michael Mauboussin.

Comments

Aw, come on! But couldn't government appear to solve this by planning all market decisions with the greatest ponderousness in long tomes everyone scrutinizes, while not really making any accurate forecasts about the long term? :-)

"while not really making any accurate forecasts about the long term?"

Vagueness for the win! Also, see the historical reference Nostradamus.

"Most academic sources maintain that the associations made between world events and Nostradamus's quatrains are largely the result of misinterpretations or mistranslations (sometimes deliberate) or else are so tenuous as to render them useless as evidence of any genuine predictive power."

It just needs to look plausibly predictable in hindsight.

I always took the CAPEX vs OPEX preference as a short termism. I know there are tax benefits, though not all the details, but over the long run it should work out. The OPEX deals always worked out to be more expensive if you would only consider the price in the deals I have seen.

Don't tell Andy Haldane...

or John Kay

The whole debate is stupid, industry does look long term and governments are hopelessly short term oriented (those five year soviet plans worked out so well after all.) About the only example of long term government planning

To take some obvious examples, most large oil and gas prospects take over 20 years from initial inception to actually returning their capital - no problems in finding investors for those. Similarly large mining projects are if anything over invested in. Even in consumer sectors, brand investments are made over decades, and we have examples of biotechnology where often it take multiple decades to bring new drugs to market.

Well, Chicago was laid out on a grid a century ago, and a huge swath of lakefront land has always been preserved from development. Someone was thinking long-term here.

And Washingon DC too, of course.

Washington.

Termism is a distraction. Or a diversion if you are a cynic. And that assessment applies to both those decrying termism and offering policies to discourage it and those defending termism (or refuting its existence as is done in this paper). Yesterday I linked an essay in the NYT by Victor Fleischer attacking Ms. Clinton’s tax proposal intended to discourage short-termism. http://www.nytimes.com/2015/07/29/business/dealbook/clintons-capital-gains-tax-change-misses-the-mark.html?ref=business. According to Fleischer, corporate executives invest corporate funds according to how the executives are taxed on their compensation and he offered a critique of section 83 of the IRC. Fleischer may be partly right, but for the wrong reasons. Reformists have long argued in favor of tying executive compensation to corporate performance. So we got stock options (thus, the reference to section 83). How has that worked out? Not so well. Executives with stock options have gotten fabulously wealthy, even as the corporations they manage haven't performed so well. Why? Because asset values are influenced by many factors, some rational and some not so rational. Should executives be rewarded when the not so rational have an outsized influence on asset values (as when stock prices are driven up by irrational investors (speculators) for reasons disconnected from the underlying earnings of the companies). Indeed, should executives be rewarded when the rational have an outsized influence on asset values (as when stock prices are driven up when long term interest rates are cut to near zero). In a world in which performance is measured by asset values rather than the return on productive capital, is it at all surprising that executives and owners of capital would be motivated by asset values.

Whether short-termism adversely affects strategy or not, it definitely affects accounting and manipulation of reported quarterly earnings numbers. The answer to this is to require taxable and book earnings to be the same.

That's a bad answer to a dubious 'problem'.

Yeah, asset prices don't support short-termism after we bailed out those most guilty of it.

“[I am] aware of no empirical evidence establishing that executive pay term is inadequately focused on long-term performance from either a shareholder or societal perspective, systematically.”

I am quite interested in how the scholar defines a focus on the long-term from a shareholder and a societal perspective. What kind of time horizon is optimal from the point of view of the shareholder and society? This seems to me like something that cannot be objectively determined and of which people have have strongly confliction opinions. Depending on one's opinion this means the actual current view of investors and business could still be too short-term.

Why is there one answer? As mentioned, oil and gas or mining investment has decades long time lines. The development of Windows 10 has taken how long? Years, and it will be on the market for two years or so. The christmas stuff to hit the shelves were ordered a few months ago. The futures markets and hedge markets which Clinton would have trouble describing how they work exist to finance things that take a long time to come to fruition, and by definition are long term.

The stock market with it's millisecond time horizons represents a fraction of the assets available, and operations that need more savvy investors than those that could be collected together by a Wall Street jackass go private equity.

I'll give you an example of short termism. In 2014 the EPA proposed that by 2016 certain very common refrigerants used in product refrigeration were to be phased out in new installations. Two years! This is a shorter lead time than the capital expenditure planning and equipment ordering schedules for much of this stuff.

There are sectors that are short term, and the reality of business means that the short term requires attention. I have payroll this friday, so I need to make sure the cash is there. But training people for what I do takes half a decade or longer, with a return on investment over the decades.

Very good comment.

On an even simpler to understand note, almost any large US manufacturer builds buildings designed to last 3 decades at a minimum. Frankly, most modern industrial buildings main structural elements should last centuries. They are far better built than the historical buildings still in use.

So where is the evidence of the short-termism?

Actually, seasonal decorations can be ordered years before the actual season.

We once wanted to sell American Greetings some Easter products...if you talk to them now, your actual order would be for Easter 2017 or Easter 2018.

Amazing.

Following the footnote, this is the scholar in question, David I. Walker: https://www.bu.edu/law/faculty/profiles/bios/full-time/walker_d.html

It's an interesting and relevant career he's had.

It's sort of obvious that pricing naturally solves this problem -- e.g. if investors are reluctant to put 30 years into growing timber, then the returns to growing timber will be higher.

The pay of CEOs of pharmaceutical start-ups correlates very well with the company's losses. The more the company is losing every year, the higher the CEO's salary. Obviously, pharmaceutical start-ups have no product to sell, and in fact are created to develop a product. The company's losses are investment in expensive research. The greater the investment, the higher the CEO's salary.

Amazon.com has not been particularly profitable, but its stock is valued very highly because it makes large long-term investments that the market believes have been and will be successful.

Drug start-ups are a small niche and Amazon is just one company. But some of the most influential investors today are pension funds, who are making long term investments. Furthermore, there isn't enough start-up capital to fund all the long term investment the economy needs, so most long term investment has to come from established companies. In general, CEOs who manage well enough to keep their companies in the black on a quarterly basis are probably better qualified to handle long term investments than CEOs who can't keep their companies profitable (with exceptions for highly cyclical industries and individual circumstances). And if a company doesn't stay in the black, it's going to have trouble funding long term investment. Companies with highly variable quarterly results will be viewed as risky, will have to pay more for investment capital, and are more likely to run into `difficulties that force them to ditch their long term investments.

Forgot to mention, as future CEOs work their way up the hierarchy, their responsibilities cover longer and longer time frames. They are given responsibility for long term investments after they show that they can handle shorter term investments. The path to the top tends to weed out managers who are only interested in immediate pay-offs. So while there are incentives to focus on quarterly results, there are also powerful incentives to pay attention to the long term.

Any "termism" operates in the environment of other organizations' termisms. Thus, depending on the competitive environment a given termism can be very bad or very good as a corporate strategy (assuming maximization of expected profits is the goal - a rather common assumption) irrespective of any personal CEO goals to optimize compensation.

As an example - in an environment with overabundant number of companies pursuing short term profits, a longer-term strategy will be very profitable. Conversely, when corporations are obsessed with the long term, short-term horizons may make better strategic sense.

There is certainly no issue that short termism is a problem in some companies. The open question is how much that just means those companies sink and others rise. I hope that people wake up and see that the current short termism is bad in the long term, and change tack. I suspect it'll be cyclical. In times of financial crisis, I think short termism takes over.

A few anecdotes in my experience include:
Working overtime at the end of the month in order to fulfil orders for the first week of the next month early, to improve monthly figures - ie overtime that ends up being worked every month for a one off benefit in the first month.
In a consulting company, stopping paid training to meet quarterly targets, for the past five years.
Stopping new hires, to meet quarterly targets, even from within, even if the people within no longer have jobs to do, but are in another division.
Increasing sales by "shipping" everything in goods outwards on the last day of the month, then booking it as "customer returns" on the first day of the next month.
Focus on selling new deals just before month end, with increasing discounts and poorer design, whilst freezing hires that would implement the deals.

1. What do call it when a politician or group of politicians write a bill that does not go into effect until after the next election?
2. Or what is the legitimate purpose of phasing in a minimum wage increase over a number of years?

BTW speaking on investors, they have funded Ballard Power losing money for about 20 years now, and yet many people say that investors will not fund long term projects. I bet you could get funding for nuclear fusion if laid out good case for a start of return in 20 years. Also people plant trees for wood and paper.

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