August 6, 2019

Damages of the short-term mindset

“Short-termism” refers to corporations focusing on short-term results to boost share prices in response to pressure from financial players, often at the expense of long-term interests

Yan Barcelo |

In March 2014, CEOs of many Fortune 500 corporations received a letter that started with these words:

“We are preoccupied… that too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons and at the expense of capital investment, it can jeopardize a company’s ability to generate sustainable long-term returns.

This was not written by a socialist economist, but by Larry Fink, president and CEO of BlackRock, arguably the largest investment firm in the world.

Fink is a powerful voice in the ongoing concern with the “tyranny of the short-term mindset” that, according to many commentators, plagues both Wall Street and Main Street. Another was Vanguard founder John Bogle, who said that “we have ceased to be investors and have become speculators”, and even devoted his last book to the subject (The Clash of the Cultures: Investment vs. Speculation, John Wiley & Sons, 2012).

Yvan Allaire, president of the Institute for Governance of Private and Public Organizations, in Montreal, defines “short-termism” as “the conscious decision on the part of management to take measures that will have a positive effect on share price in a near future, even while knowing very well that such measures can eventually harm the long-term well-being of the corporation.”

In financial markets, the most visible form of short-termism hinges on the average time investors hold on to shares, which has shrunk from 97 months, in 1950, to 7 months in 2010. However, that shortened holding period can be overly influenced by computer trading volumes, acknowledges Allaire.

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“Corporations should get their capital from an IPO and then concentrate on their core business of product, market and human resources development,” says Samuelson adding that linking executive pay to the stock price causes the separation line between two very distinct markets to blur. ”Another unfortunate outcome of linking pay structure to shares is that “it tempts CEOs to sell their company, and profit from it,” Allaire notes.

Apart from severing links between executive pay and share price evolution, Samuelson and Allaire put forward two measures that could help correct short-termism. a) Before having the right to vote, an investor should hold on to his shares for at least one year. The present state of things is the equivalent of allowing tourists and temporary visitors to vote for a country’s government, highlights Allaire. b) The longer an investor holds onto his shares, the lower should the capital gains tax be.

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