[No. 38] The Short Long

This post comes from
J. Matthijs de Jongh

The myopia or short-termism debate is not new. It is also a phenomenon that parents having small children see every day: “Daddy, I want it and I want it now.” Most often, you don’t get them quiet if you tell them that their wish will be fulfilled – tomorrow.  Executives sometimes think like children: in an important recent paper, Haldane and Davies (Bank of England) refer to a PWC survey among 250 FTSE-100 executives who were asked what they prefer: £250,000 tomorrow or £450,000 in 3 years. The majority chose the low return option sooner.

Short-termism is a serious economic problem. If future cash flows are valued at an irrational discount, companies will fail to invest in value creating long term investments. Haldane and Davies:

“An efficient capital market transfers savings today into investment tomorrow and growth the day after. In that way, it boosts welfare. Short-termism in capital markets could interrupt this transfer. If promised returns the day after tomorrow fail to induce saving today, there will be no investment tomorrow. If so, long-term growth and welfare would be the casualty.”

Over the last ten years, the myopia debate has focused on the management level. Since the dot-com and banking crises, it is generally acknowledged that remuneration schemes should strike a balance between the short and long term, rather than overvaluing short term-results.

Although it has been stated for years that also capital markets may overvalue short term, evidence was thin and possible governance consequences were barely discussed. Things have changed over the last few years. In 2010, the UK Department for Business, Innovation & Skills has conducted a started a market review into corporate governance and economic short-termism. Overall, respondents believed that short-termism exists in UK equity markets but provided little evidence to demonstrate the scale of the consequences for companies and investors. In their paper, however, Haldane and Davies provide statistical evidence for short-termism in both the UK and USA between 1985 and 2004 across all industrial sectors. Moreover, they provide evidence of short-termism having increased over the recent past.

The issue has also arrived in Brussels. In its recent Green Paper on corporate governance, the European Commission states that

“the way asset managers’ performance is evaluated and the incentive structure of fees and commissions encourage asset managers to seek short-term benefits. There is evidence (confirmed in the Commission’s dialogue with institutional investors) that many asset managers are selected, evaluated and compensated based on short-term, relative performance. Performance evaluation on a relative basis, i.e. the extent to which they outperform or underperform a market index, can encourage herd behaviour and a short-term focus, particularly if short interval is used to measure performance.”

And even more recently, the Reflection Group on the Future of EU Company Law also touches upon the issue – see Jaap Barneveld’s interesting post on this site). The reflection group argues that companies’ articles should be allowed to provide for long term shareholders preferential treatment.

The problem with a preferential treatment for long term shareholders is that it could have adverse consequences for the liquidity of the market. As marked liquidity is sacrosanct to many large investors – would some of them suffer from a short-term-bias themselves? – it is understandable that there is little interest in this issue among investors. Consequently, it is fully understandable that this issue not on the priority list for executives. Against theoretical and empirical evidence of mounting myopia, however, the lack of interest among market players is part of the problem as well.

And so seems the Dutch government. On April, 28, it responded on a request by a large majority of the Dutch Parliament to enhance long term investment. The response basically contains a list of technical issues for the legislator that are presented as roadblocks for any government initiative. I do not deny that some of the issues deserve serious attention. I also acknowledge that enhanced voting of dividend rights for long term investors could have adverse side effects that, at least in some situations, prevail. My problem with this government letter is that it lacks any economic analysis. Myopia on capital markets is not considered as a serious issue that deserves further attention or research. Technical legal issues are presented in such a manner that they hide the underlying economic problem. The government response does not consider any alternative measures that might be better than enhanced voting or dividend rights. In short, the issue is not taken seriously other than as a technical legal issue.

There is one positive side of this letter. The Minister of Justice announces a further round table discussion with company lawyers, auditors and economists to further discuss this matter. I have one suggestion for this round table discussion: invite Andrew Haldane, Executive Director Financial Stability of the Bank of England and Richard Davies to present their paper on “The Short Long.”

Comments

[Jaap Barneveld]

I could not agree more. I also noted that the letter of the Dutch government in re long-termism lacks any substantial analysis of the issue. It is completely agnostic about the problem it is supposed to tackle.

[write my essay]

As John Donovan wrote in his article "there is a culpable short-termism about Shell at the moment and one one of the world’s largest corporations cannot:
(a) Decide what its strategy is
(b) Use its huge resources to stick with that strategy over the medium to long term.

So he would humbly suggest:
(1) Concentrate exclusively on upstream and midstream oil and gas.
(2) Get rid of activities that fall outside the competances of those at the top (Refining and Marketing especially).
(3) Don’t kill the downstream with a thousand cuts – sell it as a going concern (which it is). There will be plenty of willing buyers.
(4) Get out of petrochemicals – again plenty of willing buyers.
(5) Consolidate to one Head Office. Close Shell Centre.
(6) Look for good upstream acquisitions.
(7) Really learn from the failures in Nigeria, Ireland and Russia… Get out of delusional mode. Try always telling the truth!

[blackjack en ligne]

I also recognize that the activation of the voting rights of dividends for long term investors may have adverse side effects