Market short-termism: Its extent and its limits

I began the conference on “Short-Termism in European Corporate Governance” in Antwerp with a keynote overview of four major questions about stock market short-termism. First, what is it? Second, what is the evidence of its extent and severity? Third, what are its cures and the cures’ costs? And fourth, why has it been a vivid political issue, when so much else in corporate governance is for experts and specialists, not journalists and politicians?

The first question---what is it?---is a surprising question with which to lead off. With so much talk about stock market short-termism, we should know exactly what it is. But we do not. Problems attributed to stock market short-termism are indeed some of the most severe our planet faces. But many of the deepest of these problems do not arise from the stock market’s time frame. 

Consider a global warming, climate degradation theme from the World Economic Forum---the Davos operation where many of media, political, and business leaders meet. It’s an instance of the wide attention the issue gets: “The finance world’s short-termism will destroy our communities, economies, and the planet,” the Forum was told. But the stock market’s time horizon isn’t the operative mechanism facilitating climate degradation.  The problem is one of externalities, not time horizons (as I expanded on elsewhere on the ECGI blog). Firms can be quite long-term, but as long as the stock-market-listed firms earn big profits from burning hydrocarbons, then oil & gas firms will find, produce, and refine hydrocarbons in both the short- and the long-run, unless regulated, taxed, or otherwise discouraged from doing so. They have incentives to do so because they profit without absorbing the full costs of the damage from emitting too much carbon into the atmosphere. Indeed, many of the world’s largest and strongest oil & gas companies are quite long-term operations, with planning departments considering the likely state of energy markets a decade or two or three down the road. Policy efforts to make these firms act longer-term will have limited, or maybe no, impact on our overly abundant carbon use. The system, the economy, and society are all short-term in putting too much carbon into the atmosphere, but individual companies and their stock market owners, for the most part, are not. It’s the externalization of costs and internalization of profit that’s the problem.

This conflation of externalities with time horizons can easily lead to misguided policy proposals. The EU’s Sustainable Corporate Governance Project, for example, sought to make the stock market more sustainable by orienting it to the longer-term. But since sustainability and time horizons are largely separate issues, the proposals (even if valuable otherwise) would not produce the proponents’ desired sustainability impact. 

The second question: what’s the evidence for the extent and severity of stock market short-termism? Are firms giving up longer-term value for immediate results? On a simple count of empirical inquiries, the results are divided, with about half finding short-termism and half not finding it as one would have expected. The results have a tilt---quarterly reporting tends to be associated with more short-term focus and multiple studies debunk the idea that shareholder activism diminishes long-term value in the activists’ target firms. And the results finding short-termism, when properly analyzed (which I seek to do elsewhere), tend to find it to be a small problem. A plausible conclusion for policymakers is that the data shows short-termism to be a small problem overall.

Much of the boost in policymakers’ sense that stock market short-termism is a big problem comes from seeing climate degradation as a short-termism problem. But once that’s properly seen as an externality problem, the perception of the severity of the stock market short-termism problem fades.

The third question I put forward was the following: if the best interpretation is that stock market short-termism is real but modest in scope, then what should policymakers do about it? Probably not much, particularly because most cures will have costs.[1] Yes, some firms are too short-term, but then other firms are too long-term; i.e., they persist with a losing investment well past its sell-by date. Policymakers must be careful that in aiming to reduce what short-termism we have, they could raise other costs---like exacerbating and worsening detrimental long-termism. Some firms—maybe many firms—stay too long in a business with no future.

Moreover, policymakers should distinguish local problems from economy-wide problems. That is, a firm is too short-term due to this or that characteristic (stockholders who trade too much, executives who pay too much attention to reported profits when their stock options are about to vest, etc.). Policymakers would like to cure the problem. But the problem is sometimes even less severe for the system than it is for the weakened company. I.e., if my company invests less, or does less R&D because of some short-termism, then that bolsters the profit incentive for another company, your company, without the targeted weakness to invest more and increase their R&D efforts.  Much of the empirical work in the area does not assess this potential for a systemic offset---is there one? what is its extent?---because measuring such offsets’ extent is quite hard to do. But there are natural forces that would push for some offset that would reduce the system-wide costs of whatever real short-termism that we have.

If these first three inquiries are pointing in roughly the right direction, a fourth and last question follows immediately: why does stock market short-termism have such a vivid profile in the media and among policymakers? Some explanation comes directly from the first issue:  we misattribute too much of our major externality problems (climate, environment, social degradation) to stock market short-termism.  Hence, stock market short-termism seems to be bigger than it really is. And focusing on making stock trading longer-term lets us off the hook from taking tougher, politically more difficult actions. A carbon tax has been a nonstarter in American politics; people just do not want to pay a tax on gasoline to run their cars. But a carbon tax could do much more to lower carbon emissions than making the stock market more long-term. The latter goal, however, is politically easier to strive for.

Other major explanations for short-termism’s vividness are important. There are interests that benefit from it being vivid. Executives and boards in the United States decry the stock market’s short-termism and offer that debility as reason to lodge more legal and practical authority in the board and the executive suite and as reason to weaken the authority of stockholders. Moreover, employees and social critics of the large corporation have reason to denigrate it for excessive short-termism. One reason to do so is to allow social critics to adopt a vocabulary more congenial to American political rhetoric. Criticizing social arrangements works better if it ties to financial market debilities---we’re not criticizing capital movement and ownership, the critics can say. We’re criticizing a degradation of the stock market, not the stock market itself.

This combination of interests can crowd out more worthy solutions to the social problems and to externalities. Hence, getting the rhetoric accurate can make a difference in policy thinking. Worse, sometimes interests can use the rhetoric of short-termism to push forward bad solutions.

Lastly, there’s a psychological aspect to short-termism that deserves mention. Short-termism in ordinary discourse has negative connotations: a lack of reliability, fickleness, and so on. Long-termism has positive connotations: steadfastness and reliability.  But for finance and business, the opposite is often true:  Pigheadedness in the face of rapidly changing markets could look like long-termism, but it is a cost. A company should not stick to a money-losing strategy over the long-term. It’s not good for stockholders and it is usually not good for society. And flexibility and adaptability in the short-run are advantages, even though they could be interpreted as short-term actions.  Yet, “short-term” has become a pejorative in corporate governance circles, although flexibility and adaptability—closely linked to short-termism---are qualities that should be extolled not denigrated.

Elsewhere I explored these four issues in depth.

With this keynote to the Antwerp event, I summarized their importance and the evidence.