There’s a widespread consensus that corporate short-termism is a problem. Many have welcomed Donald Trump’s call to end quarterly reporting in the hope that it might lengthen planning horizons; yesterday’s report from the IPPR cited short-termism as one reason for the UK’s lack of investment and innovation; and Richard Murphy has decried the “transient enterprise.”
- If stock market investors were short-termist, they’d under-price growth stocks and over-price those offering near-term cashflows. In fact, more often than not they’ve done the opposite. Growth stocks have under-performed value ones in the UK over the last 30 years*. That suggests investors have been too long-termist.
- The profits to innovative activity have been low: William Nordhaus estimates that firms have captured only a “minuscule fraction” of the overall benefits of innovation**. This suggests that low innovation might be due to a realistic assessment of its pay-offs rather than to irrational short-termism.
- Suresh Nallareddy and colleagues show (pdf) that the introduction of quarterly reporting in the UK had “virtually no effect on investment decisions, as proxied by capital expenditure; levels of plant, property, and equipment; R&D, and intangible assets”.
- Charles Lee and Salman Arif show that when firms do increase capital spending, it leads to lower GDP growth and more corporate earnings disappointments. This suggests that low capital spending is rational.
In fact, it might be that a reason for low innovation and investment is not that companies are too short-termist but that they are too long-termist. A good reason not to invest is the fear that profits will be bid away by future, cheaper, technologies. Uncertainty is much greater about the long-term than the short-term: firms can know who their rivals are today, but have no idea who they’ll be in (say) ten years’ time. And uncertainty is a reason not to invest. This is especially the case if Rosewell and Ormerod are right, and that companies have no idea about the future.
Plenty of firms are niche businesses, filling a gap in the market. But niches can exist in time as well as space. Profits are not persistent. Corporate death rates are high. This isn’t simply because many are badly managed (though they are (pdf)). It’s also for a reason pointed out by Peter Rousseau and Boyan Jovanovic. Firms, they say, embody specific vintages of organizational capital – the best practices and technologies at the time they were founded. Sometimes, though, better vintages come along, so firms must adapt or die. Adaptation, though.is difficult***; you can’t teach an old dog new tricks, as Gooners watching Petr Cech this season know. Rational bosses, knowing this, might be loath to expand.
None of this is to deny that bosses have plundered ailing companies such as Carillion and BHS. The problem in these cases, however, is not their irrationality but their excessive power.
Now, many people might interpret this denial of short-termism as a problem as a defence of capitalism. It’s not. Quite the opposite. We could just as well draw exactly the opposite inference: maybe low investment and innovation are deep-rooted features of modern capitalism which are not so easily eliminated by tweaks to corporate governance.
* By 1.8 percentage points per year in total returns, if we compare the FTSE 250 high yield and low yield indices.
** Apple is an obvious exception to this. This is because Steve Jobs genius was not so much as an innovator as in being a creator of brand power.
*** Ironically, Whitbread – the firm cited by Richard – is an exception to this.