Many experts, pundits and policy-makers have proffered opinions regarding the impact of short-term thinking in the modern business world. The two main streams of argumentation are, first, is so-called “quarterly capitalism” really a problem, and if so, what can we do to swing the pendulum back to a more appropriate balance of short-term and long-term business management.
The Conference Board recently published a report titled “Is Short-Term Thinking Jeopardizing the Future Prosperity of Business?”. This hard-hitting report focuses on one of the key problems of post-modern capitalism: How do we prevent the counter-productive short-term corporate mindset that ultimately only enriches management and hurts the shareholder and economy at large.
The first step in the process is to make more of the general public aware of the problem and the very real impact it has on them and the prices they pay for everything from milk to auto insurance. A certain critical mass of public opinion is required to effect any lasting change, so the efforts of organizations like The Conference Board to produce informational reports explaining the issue are certainly valuable.
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Four factors driving short-term thinking in business today
The Conference Board Report highlights four factors that have played a notable role in today’s short-term focus in business: Executive compensation design, quarterly capitalism, activist hedge funds and capital markets moving from investing to trading.
Executive compensation design
One clear and obvious problem relating to the problem of short-term thinking on Wall Street is executive compensation design. Moreover, this issue is relatively easy to solve if corporate boards stop being so friendly with management and live up to their fiduciary duties to represent shareholders.
The problem is that most of the “performance bonuses” for senior execs on Wall Street today are directly tied to short-term indicators such as earnings per share or a one-year stock price target. This obviously incentivizes execs to focus on the short-term indicators to fatten their own bank accounts, which is almost always not in the best interests of the company or the shareholders in the long run.
The CB report also notes that the pressures of “quarterly capitalism” push against corporate management from all sides, especially from their own shareholders (see activist hedge funds below). Several recent surveys, including a survey of 1000 senior execs by McKinsey&Company, suggest that senior corporate management feel pressured to produce results every quarter, and do feel they are missing potential long-term benefit because of they are “forced” to think short term.
Activist hedge funds
So-called shareholder activism has been on the rise for several years now, and the trend shows little sign of slowing down. Studies have shown that shareholder activists do often see an increased return on their investment after their intervention. The uglier other side of the coin is that workers at the targeted firms, however, tend to lose their jobs and have their pay and benefits cut.
The CB report points out that one of the primary demands of most shareholder activists is to “return cash to shareholders,” which is most definitely short-term thinking.
Capital markets moving from investing to trading
Finally, it is important to remember that the culture of financial markets has also changed over the last couple of decades. It’s no longer about investing, it’s about trading, even if many funds are still long term oriented many others are not. As the report highlights: “Trading does not provide capital for investing in a business; it simply flows capital between shareholders. Stock markets have largely become trading platforms through which capital is directed not to business but to traders.”
See full study below.