Rick says that UK companies are too short-termist, and that Carillion – which paid big dividends until soon before collapsing - is a manifestation of this. I’m not so sure.
Of course, some firms, like Carillion, have short-termist bosses and subsequently collapse. But is the collapse because of the short-termism? Or might it be instead that short-termism is a response to the prospect of collapse, and that rational managers, sensing their business is destined to fail, take money out of it?
And very many businesses do fail. The ONS shows that around 10% of firms cease trading each year, and less than half of them survive five years. Granted, failure rates are much smaller for larger or older firms. But in the long-term they are still considerable. For example, only three of the UK’s largest employers in 1907 are independent stock market-listed firms today. And a list (pdf) of the original constituents of the FTSE 100 when it was formed in 1984 contains plenty of firms that subsequently declined. A failure rate of only 3% a year means that firms have a less than 50-50 chance of making it to their 25th birthday.
If you’re not going to survive into the long-term, why not be short-termist?
And in a healthy dynamic economy, we should see lots of failures as competition and creative destruction eliminate profits. It’s only monopolies or near-monopolies that can fight off competition for many years and afford to be long-termist. Do we really want that?*
What’s more, creative destructive means there’s uncertainty even for firms that do (with hindsight) survive. This uncertainty compounds over time. On a two or three year horizon, most decent firms have a reasonable idea of where the threats from rivals or new technology come from. On a two or three decade view, however, they have no clue. Faced with that uncertainty, why not focus upon managing the company well in the short-run?
In this context, long-termism isn’t necessarily a virtue. It might instead reflect merely irrational overconfidence. Yes, short-termism might well be one cause of low capital spending. But high investment doesn’t guarantee success. As Charles Lee and Salman Arif show, it often leads instead to lower profits. This is consistent with high investment being a sign not of rational long-termism but of irrational over-optimism.
We have some more empirical evidence here. Let’s say that stock markets were too short-termist. In such a world, we’d expect them to under-price growth stocks and pay too much for stocks that pay high dividends. Generally speaking, though, the opposite has been the case. For most of the last 30 years, high-yielding shares in the FTSE 350 have out-performed lower-yielding ones: the main exception came between 2003 (when tech stocks were under-priced) and 2010**. And the FTSE Aim index – which contains many “growth” stocks” has horribly under-performed the All-share index since its inception in the mid-90s. This tells us that stock markets have generally paid too much for growth and too little for dividends. They have been too long-termist, not too short-termist.
Of course, managers can be as irrational as the rest of us. But it’s possible to be too long-termist as well as too short-termist.
The biggest problem with corporate governance – as highlighted by Carillion - is not that bosses are too short-termist, but that they have too much power to plunder firms for their own private gain.
* There’s a big difference here between the UK and US: the rise of monopoly power is more pronounced in the US than UK.
** In fact, given the big decline in long-term interest rates we should have seen growth stocks boom in the 00s as investors discounted future cashflows less heavily. That this didn’t happen is yet more evidence that growth stocks have been over-priced.
You really have to define what you mean by short termism.
With executive pay heavily defined by quarterly profits - that is the time horizon, 3 months. The motivation here is to maximise short term profits by reducing future investment, staff training, research and development, sales and customer staff but boost the media and PR staff. The CEOs etc take the bonus and aim to get out quick as the long term sustainability of the company is about zero. Short termism is absolutely terrible for UK business as the abysmal productivity figures and huge numbers of untrained staff show.
Stock markets are even more short term minded - some shares are only held for seconds. In 2012, the average time for which a stock is held – went up from 20 seconds to 22 seconds. "Most trades are computerised. Most trades are short-term. The average foreign currency investment lasts – it's up now to 30 seconds, up from 28 seconds.
This is the reason why firms paying high short term dividends are rated highly. As the CEO makes investment and staff cuts the share price goes up - not down. Stock owners take the dividends then sell before the crash. They have zero interest in acting as responsible stakeholders. Several utilities actually borrow money to raise the share price and CEO bonus - plus the UK gives them tax relief on their debts.
Posted by: joe | February 12, 2018 at 05:34 PM
«Or might it be instead that short-termism is a response to the prospect of collapse, and that rational managers, sensing their business is destined to fail, take money out of it?»
What about if this applies to investors and countries? For example english investors and England? That is, theymight have decided (decades ago) that England was going forward a low-profit location, and that there were much better profits to be had in the plantations of the colonies, in the growing industry of the USA, in the rapidly developing economies of the third-world?
They might have decided to liquidate or work their assets in England as much as possible and underinvest in plant and research...
Posted by: Blissex | February 12, 2018 at 11:22 PM
«And the FTSE Aim index – which contains many “growth” stocks” has horribly under-performed the All-share index since its inception in the mid-90s. This tells us that stock markets have generally paid too much for growth»
Well, the AIM is not so much "growth" but "caveat emptor" stocks, so not surprising.
Moreover the question is what "growth" means here. In the stock market is means "share price growth", not necessarily sales growth or profit growth.
While the discussion about short-termism is about companies as businesses in the economy, not as punts in the stock market.
Posted by: Blissex | February 12, 2018 at 11:27 PM
Seems to me the long term is merely a concatenation of short terms. A truly long term plan is only possible for a well understood and obviously well funded project - an oil pipeline say or an under city tunnel. Any other project is buffeted by changeable political, technical and economic winds. The key is to join the short term segments together in a coherent way - if you want to.....
That all assumes the business model is intended to survive and not be looted. Then we must consider the role of the buyer in say big outsourcing contracts. Whilst good commercial negotiation is necessary a policy of only to the cheapest and screwing the supplier to the wall is not sensible and only encourages short term thinking on both sides. Perhaps the UK would do well to abandon its adversarial approach to politics and to legal matters.
Posted by: rogerh | February 13, 2018 at 12:55 PM
«abandon its adversarial approach to politics and to legal matters.»
That usually works better in ethnically and class homogeneous cultures. My impression is that unfortunately in the UK there are significant ethnic and class (which often overlap) differences, with "cavaliers" who regard "villeins" as unpeople, and centuries and more of distrust and worse by those "villeins" for their masters.
Of the many things said by D Cameron, "we are all in the same boat" is probably the most outrageous, unless he meant "we" to cover just himself and his mates and relatives in "The Establishment".
Posted by: Blissex | February 13, 2018 at 07:59 PM
It seems to me this point could easily be used to argue that kalecki was wrong about capitalist opposition to a policy of full employment. Businesses behaving in short term interest would prioritise profits from a fiscal stimulus aimed to achieve full employment, instead of the downward pressure in the long term as the result of such a policy.
Posted by: Chris | February 15, 2018 at 02:46 PM