From the comments

Tyler,

Isn’t it funny how so many people hold these two opinions in their heads at the same time:

1) Wall Street is just focused on the next quarter and they push corporations to have short term motives.

2) There was a stock market bubble 15 years ago built around bidding up prices to unprecedented levels for an entire basket of firms which had never been profitable and had no near-term plans for being profitable.

That is from Kevin Erdmann, Kevin’s blog is here.

Comments

Why can't both be true?

Sure. So lets write another 12,000 pages of regulations. Or better yet, tax the hell out of it all so it goes away.

What?

It's Vaguely Libertarian Non Secuitar Man. Didn't you recognize the cape?

Actually laughed at that one.

It is known as the difference between what Wall Street is buying and what they are selling. Wall Street does not equal Investors. The other point is that was 15 years ago and did bust though there are some inklings of a return.

That seems to misunderstand what the hypothesized short term motives are hypothesized to be motivating. Nobody claims that the stock market pushes people to boost short term *profits*, the claim is that firms are pushed to boost short term *stock prices*, by making themselves look good temporarily even if it's unsustainable. One way of looking good is to have a lot of profits (which might come from burning goodwill or other hard-to-measure capital), but another way is to sell pie-in-the-sky stories of infinite growth and market dominance and the promise of technology (even if those stories will eventually come into contact with harsh reality).

I disagree, lots of people claim that stock markets and private actors in general are not prepared to invest in projects with uncertain and / or long-term payback

To pick Tesla Motors as one example, I would say it is almost certainly true that stock investors, in general, are not prepared to invest in projects with uncertain and/or long-term payback. Again, that is a general proposition so there are undoubtedly some companies or industries that manage to make the hard sell successfully to the investing public or take advantage of a temporary period of euphoria to raise money on the markets. In the case of Tesla, according to Wikipedia, it took seven years before the company went public and it went public only after it started to post profits. Before then, it was very closely held and survived on Elon Musk's personal fortune, the Abu Dhabi sovereign wealth fund, Daimler, and a nearly half-billion dollar loan granted by the federal government.

Irrelevant. No one has argued that the stock market is or should be the only way to finance companies

"a nearly half-billion dollar loan granted by the federal government."

That's nice. At least Tesla is serious. Many other green car companies were not and essentially abused these loans.

But we could take another example: solar power panels. Wall Street poured money in Chinese firms. I recall one Chinese company received a billion dollars of investment before even building a production facility.

Solar panels seem equally speculative as Tesla.

Except payback comes in terms of stock price.

Stock markets and private actors probably are reluctant to invest in buisnesses that require a substantial capital investment up front but won't signal positive results to the uninformed investor for many many years (e.g. R&D where the positive signal could come at any time but often takes many years). Such investments might be in the institutional interest of a company making the investment but are in conflict with the incentives of any individuals in that company who will no longer be in a position to be substantially rewarded or punished when results come in but will be seen as underperforming before they do.

In contrast the individual incentives to invest in a bubble and reap the immediate profit (pocketing the bonuses and pay regardless of any future collapse) are extremely strong.

The first assertion, though, is claiming that since Wall Street is focusing on such short term focus helpful investments and long term repairs are neglected in order to generate short term results. Instead of painting the factory this year, we'll claim a slightly lower level of expenses which will cause us to beat estimates by a half penny and boost our stock price. It will mean in ten years, though, we'll have a much larger amount of wear and tear which will eventually cost ten times what the paint job costs now...but that's a problem for the manager a decade from now if this company is still around.

But this would conflict with your assertion that business can sell Wall Street 'pie in the sky stories' where low profits now are due to smart investments that will generate huge margins in the far future (think Amazon back in the 90's). If Wall Street is willing to buy into such stories why are they not able to buy into companies that are experiencing slightly lower profits or cash flow now because they are making wise use of their resources to ensure their long term health?

proclaiming a long term strategy is often used by scamsters with a short term mission, no? by the time the long term strategy has definitely failed the scamster is gone.

I don't think you know what the word funny means....

The stock market is perfectly irrational, therefore unpredictable, therefore it superficially looks like the EMH holds and the market is perfectly rational.

Termism is a distraction from a more in depth look at what's ailing the economy, in particular inadequate investment in productive capital, not unlike the end of technology explanation or, and this has to be the topper, the section 83 explanation that the NYT published this week. Today's NYT has a review of a new book, Wealth Secrets of the One Percent, in which the author advises that the secret to wealth is monopoly. No, Thiel didn't write this book, but that's Thiel's advice too. The author says nothing about termism - long, short, or anything in between. Monopoly. Adam Smith is dead.

Adam Smith said that businesses always should and do seek monopolies and that competition is what keeps them from getting monopolies or holding onto them for very long. Adam Smith is alive.

Firm heterogeneity. Investors are betting on firms future cashflows. What "future" means depends on the nature of the firm and the nature of the industry where the firm operates.

Let's see. Professional stock traders are no better at picking stocks than monkeys. Some take a long-term view and are bad at that. Others take a short term view and are bad at that.

The legimate complaint Tyler and other Serious People continue to elide is that many traders bet big using other people's money on high risk trades because they care entirely about the short-term and nothing about the long-term. (In the long run, they are all rich and retired.)

So now Tyler and other conservative economists are pretending this complaint has to do with all public companies instead of the ones with traders who bought mortgaged backed securities when that was obviously a dumb long-term bet.

Well said.

Yeah, about as well put as a confused bluster can be.

Well said? If what dirk claims the problem is, is in fact, what the problem is, it could be so easily solved by avoiding active funds. No need for a grand Democratic 500 billion dollar program, and if not to create a bureaucracy, why would any of you be interested in solving it?

"all public companies instead of the ones with traders who bought mortgaged backed securities when that was obviously a dumb long-term bet."

Fannie and Freddie. FHA. Lots of non-Wall Street people involved.

"obviously" a dumb long-term bet. So you shorted right?

If necessity is the mother of invention, then volatility breeds experts. Aggressive price movements creates so many people in the knew.

Can someone close to Mr. Erdmann explain to him that the stock market invites the participation of many "investors" who have different expectations of the future, and how far away that future is?

Why? That's exactly why you would not expect termism to be exogenous to company characteristics. Arbitrary termism on public companies is an exploitable condition.

Isn't Erdmann's comment political...not financial? I would guess that the "so many people" holding those opinions do not own stocks.

1. There is clearly earnings (accounting) manipulation that goes on to boost/smooth quarterly results that has no economic value. Is this a big problem?

2. It's absolutely true that Wall Street and the financial press watch quarterly results like a hawk and that they drive short term stock prices around.

3. Neither 1 nor 2 prevent companies from also having long term strategic plans and objectives. That doesn't mean 1 and 2 are good/desirable.

4. The internet bubble comparison above is apples to onions. Just don't see how they two issues are even related. Investing in a large operating company and a lottery ticket IPO are kind of different.

Stock markets being either a) short term or b) basically gambling on lottery like payoffs from unprofitable "hot" tech firms despite a lack of any long or near term plans, really isn't very contradictory.

Although, this said, I am generally skeptical of people who place the blame for various undesirable phenomena on a lack of so called "future time orientation". That's a bs concept (impulse control is real and the intelligence predict the future is also real, "future time orientation", to the extent it is distinct from both of these, is not real or not necessarily a good trait if it is real).

It's funny when people point out an irony that a slightly greater intelligence would dismiss as not an irony at all.

In high school I went to an information session for prospective students at UCSD. While everyone waited beforehand, they were projecting onto the big screen comical ironies like, "Why is it that when you're looking for an address, you turn down the radio?" The audience all laughed. Holy smokes, I thought, these people are stupid.

The question, in my mind, is not whether individual traders employ short term thinking.

The question is what institution, as a whole, is more capable of focusing on the long term over the short term? The financial markets? Or the Political process?

To me the answer is obvious and is not even close.

Here's a post from a while back about apparent short-termism, or the inability of the market to completely price in management obfuscation.

http://idiosyncraticwhisk.blogspot.com/2014/02/ceo-candor.html

Although, in hindsight, I treated CEO candor as a sort of ceteris paribus factor, so that market prices would have to decline in relation to forward earnings. But, reading it again, it could be that CEO candor is positively related to other beneficial organizational trends. If that is the case, it wouldn't change the fact that there is a lag in market price discovery, but that would be reflected in higher productivity improvements, not just lower absolute current prices. Maybe there is momentum for valuation changes related to candor just as there is with other valuation factors.

Oh, and thanks for the shout-out, Tyler.

The two notions do not seen inconsistent, although either or both may be false. What is Erdman's model that shows the two behaviors are inconsistent?

Concur, the observation fails. The premise underlying the purported humor is that a) "Wall Street" is a monolith; and b) a universe with quarterly report syndrome cannot possibly also contain a speculative frenzy.

Here's a better one:

How can high-frequency trading and "quarterly capitalism" both be bad?

I don't get your point. Could you elaborate?

Commenters: Combining a shotgun presumption of failure with a motte and bailey treatment of the scale of that failure sort of demonstrates my point in spirit while refuting it in substance.

Good one Kevin.

Believing Wall Street undervalues long-term value production, one should invest in presumably underpriced long-term value production opportunities.

But note that money has a time value and if the Great Stagnation is real the discount to future money must have increased because we now expect the future to be less productive than we did before (i.e., we'll enjoy our future money less than we thought we would).

It's even funnier how most of "those" people tend to work, be associated with institutions like government which over reacts to short-term non problems, and addresses real problems by kicking the can forward -- beyond one election if its is a serious problem, beyond one generation if it is a super serious problem.

Oh, I don't know. You can find cognitive dissonance everywhere.

Get ready for 14 months of "The Iraq invasion was the greatest foreign policy blunder in our lifetime" in the very same breath as "We need to take a Senator who voted for it and make her President of the United States."

The underlying cause is almost always this: Someone who is full of crap is trying to sell you something.

Both points are consistent with the view that Wall Street doesn't care about sustainability, and pushes companies to give good immediate results without much attention to the details. 15 years ago, many companies were showing great short-term results, consisting entirely of raising venture capital, and had no vision for revenue, which would only be necessary in the long term in that environment.

As Kevin points out, obviously the market doesn't have a "short-term" bias in the simple sense: prices reflect expected payouts many years into the future, especially for growing tech firms.

The problem, to the extent that there is one, is really asymmetric information and the resulting moral hazard. If executives are judged primarily on the short-term behavior of the stock price, then they will be biased toward increasing the currently *perceived* value of the company, rather than the actual value. In principle, this could be a problem for almost any time horizon (two years or twenty years), but presumably it gets worse as the consequences recede further into the future - because then they’re more likely to be subtle and opaque to outsiders, and not reflected in the current stock price.

Of course, this isn’t a failure of equity markets alone - instead, it’s a standard and quite general principal-agent problem. The problem is even more severe for governments, which are coarsely evaluated (with the entire government being voted up or down, rather than 100 separate departments taken individually) by voters with minimal incentives or resources to collect the relevant information. This unpleasant implication is probably why left-wing critics of short-termism, even when they make some good points, end up leading themselves in circles.

One funny part is that this behavior is very hard to *prove*, because any readily observable piece of information *will* be incorporated in the stock price. CEOs shouldn’t be biased toward less R&D spending or investment *as these concepts are measured in the data* - because stock prices will fairly reflect the value of an incremental dollar listed as being spent on R&D. On the other hand, CEOs will be biased toward doing *fake* R&D, classifying current expenditures as long-term investment and avoiding the real and unmeasurable choices with long-term benefits; but these unmeasurable choices, almost by definition, are hard to detect in a study.

When studies do find some effect, therefore, generally either it’s spurious or it reflects some deeper sorting. For instance, companies that suffer less from short-termism might specialize in R&D because they’re the only ones that can be trusted to do it properly. If this is true, it suggests that short-termism is a legitimate problem - but it also implies that the market can efficiently redirect resources toward the right organizational forms, and that maybe we don’t need a policy intervention on top of that.

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