Don’t Blame Stock Markets for Peril of Short-Termism

Mark Roe is the David Berg Professor of Law at Harvard Law School. This post is based on an op-ed by Professor Roe that was published today in The Financial Times and is based on his paper, Stock-Market Short-Termism’s Impact, (discussed on the Forum here).

Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); The Uneasy Case for Favoring Long-term Shareholders (discussed on the Forum here) by Jesse Fried, and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here).

The Business Roundtable, a prestigious organisation of the CEOs of the largest American companies, last week urged large public companies to stop telling investors what senior executives expect quarterly earnings will be. Their effort arises from the widespread belief that the scourge of market-driven short-termism is seriously damaging the American economy. Ending this quarterly earnings advice would help. Respected business leaders like Jamie Dimon and Warren Buffett have promoted the idea under the headline that “Short-Termism is Harming the Economy”.

The advice on forgoing advance projections of quarterly earnings is sensible as such efforts largely waste managerial time—the earnings will be announced soon enough. But the thinking behind the advice, that market-driven short-termism is seriously harming the American economy, is unsound. Critiquing short-termism is now an idea whose time has come and, for many, its severity is so obvious that the idea needs no support. Like the recent attacks on open trade, basic marketplace advantages do not seem as advantageous, even to market leaders like the Business Roundtable, as they once did.

Short-termism driven by stock markets is said to come from rapid trading in American equities and stockholder activists at hedge funds pressuring executives for immediate results and cash, pushing executives to take short-cuts. Three ways of stock market short-term degradation of the economy are regularly repeated and widely accepted without question.

First, short-term stock markets punish companies that do research and development; R&D expense comes now, pay-offs in better products come years later. Diminished R&D compromises the economy’s future. Second, companies are draining their cash by buying their own stock back at a torrid pace to keep cash-hungry investors satisfied. With the cash gone, the companies’ capacity to perform deteriorates. Third, the US, which more heavily depends on stock markets than most of the rest of the developed world, is investing shockingly less in capital equipment, factories and new businesses than its peer nations.

But none of these three core short-term ideas is true. R&D spending is rising in the US. The Department of Commerce’s data are clear and unambiguous.

Yes, stock buybacks are up—hundreds of billions of dollars of stock has been bought back in recent years. One might mistakenly think cash is therefore draining out. But it isn’t, because large US companies simultaneously also increased their net long-term borrowing by hundreds of billions of dollars. Cash isn’t draining out when one combines the two. Cash out to buy stock; cash in by borrowing more. Too much debt, even at today’s bargain-basement interest rates, is not always for the best. But it isn’t a short-term, quarterly problem and it’s not draining cash. Recommended Equity earnings Investors deliver harsh verdicts on earnings calls

Capital spending on new machinery and equipment is down in the US—unambiguously. But, capital spending is down across the entire developed world. It’s down in countries like the UK that also depend strongly on stock markets and it’s down in Germany, Japan and the rest of the developed world, including the countries that do not depend on stock markets as much as the US.

Something else is happening—more efficient use of existing equipment due to better IT, post-industrial economies using less heavy capital than before and movement of basic manufacturing to China and elsewhere. The developed world’s capital spending decline deserves understanding but if such spending is falling both in nations oriented to stock markets and those not so oriented, then looking to markets as a central explanation is a dead-end that leads to irrelevant or even damaging policy solutions.

Why is the economy-wide data so inconsistent with such widespread belief in market-driven short-termism? One reason is that we’re specialising more: venture capital firms now do the R&D in some sectors better than the big public companies. Second, many public companies have kept researching and investing but the problem cases get headlines and political attention. Third, and in my view most importantly, technology is moving faster than ever. Product cycles are shortening. Hard-won skills for employees and companies are displaced faster than ever, thereby disorienting, disrupting and angering those who worked hard for skills that the next technological shift undermines, hitting them hard.

Something broader may be going on. Some executives—like many in the Business Roundtable membership—may exaggerate short-termism because it justifies executives, not shareholders, always having the final word. And for many citizens and political leaders, short-termism has become a catch-all complaint against Wall Street and the large public company. Real problems like neglecting employees’ welfare, environmental degradation and the disruption resulting from increasing speed of technological change are too often labelled as market-driven short-termism.

These are real problems. But they are long-term problems. Thinking about them as short-term problems will not fix them.

The complete paper is available here.

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One Comment

  1. Charles Nathan
    Posted Wednesday, June 27, 2018 at 2:45 pm | Permalink

    Mark, I enjoyed your article and think it is truly seminal. I congratulate your original thinking and research which has produced what I am confident will be an opening salvo in the debunking of the short-termism myth that is so pervasive today.
    Best, Chuck Nathan

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