While on a Sunday stroll, I encountered Jerry Muller, author of The Mind and the Market, among other works. He asked me what I thought about “short-termism.” Mostly, I think that it is a difficult concept to pin down.
I guess my working definition would be that short-termism is a bias among executives to forego long-term opportunities in order to achieve short-term profit objectives.
But how would you measure it? What observations would confirm it?
For example, I might argue that, at today’s low long-term interest rates, a nuclear power plant looks like a high net-present-value investment for a utility company. Does their failure to invest in nuclear power plants reflect short-termism? Obviously, it is more complicated than that. There are regulatory barriers, site licensing barriers, and there is economic risk–suppose that ten years from now solar power becomes so inexpensive that the price of electricity no longer provides a decent return on the up-front investment? Not to mention the risk that the plant will have something wrong, or that the nuclear waste will be a problem, or some other risk.
The point is, it is very hard to separate pure time preference from risk when it comes to real-world investments.
Some other thoughts:
1. For the economy as a whole, most pundits think that the big long-term investment opportunities are in energy, computers/communications/robotics, nanotechnology, and biotechnology. My impression is that biotech is perhaps being held back by regulatory issues. But otherwise, I get the sense that investment is pretty active. Google certainly is making some long-term investments.
2. Sometimes, the financial crisis is blamed on short-termism. But there is very little evidence that the banks knew that they were making short-term profits that were going to turn sour in the long term. Instead, it seems that they believed that things were fine, both short term and long term.
3. If you were going to advise a firm to sacrifice some short-term profits in order to undertake long-term investments, which firm would that be? What investment should it make? Can you be confident that it is short-termism rather than concern about risk that is inhibiting the investment?
I think it is government.
Right. It’s all public choice.
Corporations have to worry about investors doing different present-value estimates over a long-term time horizon, and CEO’s get paid based on stock-movements influenced by those estimate; the ‘sacrifice the future for short-term profits’ meme seem unsupported.
Individuals, who are pretty temptable and impulsive and make lots of time-inconsistent choices, nevertheless tend to live unexpectedly long lives and thus face a fairly long-term optimization problem.
But politicians start the next campaign the minute after getting into office. If they can win today and push some hard-decision time-bomb off until tomorrow, then why not push it off? Voters don’t play the role of shareholders if they can be fooled into thinking ‘somebody else, not me’ will end up holding the bag when the time-bomb goes off.
Your definition of short-termism, a bias among executives to forego long-term opportunities in order to achieve short-term profit objectives, is pretty good. Most every top executive oversaw the issuance of junk bonds, and bought back stocks, and increased dividends to drive up share value.
Day traders, since 2008, using margin debt and investing for short term investment gain, practiced short-termism.
The age of long term investing is over, through finished and done as the bond vigilantes have called the Benchmark Interest Rate, $TNX, decisively higher to 2.74%.
Get this and get it right: the money bubble has finally burst, as both Equity Investments … http://tinyurl.com/m4azweu … and Credit Investments … http://tinyurl.com/kuqobnm … are trading lower from their April 10, 2014, highs.
Please understand, and please do not weep: A new financial crisis has commenced.
For almost all firms, short term profit is required to fund long term plays. For many (including in software) short term market share is a huge factor in middle or long term market share. And so there isn’t always a trade-off between “profit now” and “profit later” – often it’s “profit now or be doomed”
And while the software and computer industries as a whole are very much very long term plays (albeit constrained by the issues above) there often is no such thing as an explicit long term investment. Because literally everything you do will be utterly obsolete in a short time span, and the assets that are important to control won’t even be visible until some time in the future.
I think the utility industry is a poor example to contemplate because they are so heavily regulated – not just as monopoly providers, but all sorts of other constraints.
(For example states that have rules requiring power to come from renewables, or I suppose some that have rules forbidding this or that technology. I’m not talking about regulations related to the plant site, I’m talking about regulations related to source of the product *as delivered* to the state the monopoly serves. So for example Nevada might let you build a Nuclear plant but CA might not let you sell the power.
So far as I know these issues are pretty peculiar to the power industry.)
It’s funny how many people believe the financial industry is inefficient because:
1) It is congenitally short-sighted.
2) we have just been through two financial bubbles that involved massive over – investment in technology firms that could not have been profitable for years, if ever, and massive over – investment in housing and other durable assets.
And, to top it off, this is usually coupled with the belief that redistribution from savers to spenders is beneficial to the economy.
People are funny.
Observations that may be consistent with short-term thinking:
1. Massaging earnings to match forecasts to the penny.
2. Lots of non-GAAP accounting.
3. Resetting management option prices.
4. Channel stuffing.
5. Low R&D spending.
It would be interesting to arrive at a comparative definition of short-termism.
For example, if CEOs have incentives to act short-term, that is differentiable from irrational short-termism.
I think that when many people think of short-termism, they’re thinking of things like cutting materials quality or customer service, or employee training in order to achieve or increase an immediate profit. Not so much areas of investment (save maybe basic R&D).
Corporate America as a whole can be indicted, given record stock buybacks paired with record low capital expenditures.
A particular corporation that should be singled out is IBM. David Stockman did a great writeup the other day where he noted that 100% of IBM’s net earnings since 2007 have gone to stock buybacks. IBM’s revenue has now stopped growing, and IBM is now selling its x86 server business (having sold its PC business years ago).
To meet its aggressive $20 EPS target by 2015, the company is radically laying off workers in developed countries, including 78% of its US staff.
This has seriously harmed IBM’s services business, as there no longer is experienced English speaking staff to solve problems. It used to be that IBM had everything under one proof and gold-plated service, hence the saying, “No one ever got fired for buying IBM.” That’s certainly not true anymore.
At a minimum, instead of stock buybacks IBM should be investing in good customer service. IBM should also be investing in the next generation of big iron servers as cloud computing goes more popular, and perhaps only IBM has (or had) the resources needed to match grid computing with cloud computing.
I’ve followed IBM closely, but I’d be willing to bet similar problems exist in many American multinationals.
A couple of comments:
1) +1 to Kevin Erdmann (this is obvious to those of us who work in investment appraisals)
2) giving back money to shareholders when you realise that they can invest them better elsewhere is sound finance, not short-termism
Stock buybacks paired with stock options constitute self-dealing at the expense of the investors. Sure, the stock price increases (for now) but at the expense reducing the investors’ REAL wealth. This sort of behavior is perhaps justified when you are a monopoly service provider with no obvious competition, but not otherwise.
No, the stock buyback does not do this. Stock buy-backs, like dividends, gives the money back to shareholders so that they can invest them in something else with better returns
This is at the expense of the investors who choose not to sell their shares.
The corporation’s balance sheet is weakened, reducing the real wealth per share. The paper value per share increases, but like all market valuations this is ephemeral.
In most cases today, the money would be better spent investing, especially in the case of IBM.
Seems like someone has spent too much time watching CNBC.
1) the total balance sheet reduces but so does the number of shares. the value per remaining share is not necessarily reduced
2) the fact that the money is not invested by the IBM doesn’t mean that it’s not invested.
3) “this stuff” is not from the CNBC but second term or so of any serious corporate finance course in university…
4) believe me, the mgmt of a company would much rather sit on the money than give it back to shareholders, it would increase their freedom to move and allow them to e.g. increase the size of the enterprise they control. It’s the shareholders that want their money back
Well, the advice to Wells and Fargo, Plant, Adams, Butterfield would have been to do whatever it takes to deliver parcels to customers in rural as well as metro areas before 1900 to gain a lock on a highly profitable business before progressives got so frustrated that through the Grange they got Congress to provide RFD service that naturally led to Parcel Post that became hugely profitable.
One can hardly fault James Casey for failing to create national consolidated parcel service beginning in 1907 with just his $100 debt, and when he started with his acquired partners consolidated deliveries in 1913 he was merely copying the Post Office. But perhaps he could have made a point of shipping children as parcels in 1914 when the Post Office banned mailing people by Parcel Post.
The railroads looked to short term profit and pissed off farmers, as did all the delivery companies that operated over roads and cut deals with railways It was their short term profit maximization that led to the progressive/populist movements from the heart land, by grange organizations, that resulted in the ICC, anti-trust, and the Federal government being forced by voters to take control of all aspects of transport policy.
The Post Office offered limited service and cost taxpayers and required you go to them for centuries in the Americas and it was only the failure of the private sector to invest in the long term national universal service the voters wanted that led to the Post Office becoming so profitable it could cut rates while expanding and improving service until concerted political opposition to the government providing such great service the private sector just couldn’t compete except in some niches.
After all, if the private sector is so superior to government, why didn’t UPS or FedEx or Wells Fargo or others already provide in 1900 what the Post Office provided in 1915 after just two years of Parcel Post and a decade working on universal RFD.
Emil:
1) For the wealth per share to remain unchanged, the number of shares must be reduced in the exact same level as the amount of cash expended to buy back shares. This is not always the case.
More ominously, a corporation that is not investing (whether traditional capital investment, or expenditures on R&D) is going to have reduced future earnings unless it is a monopoly service provider. This means that a program of aggressive stock buybacks will reduce the future wealth of the stockholders.
2) True, but given that capital expenditures are at a postwar record low level and stock buybacks are de rigeur across the Fortune 500, not much investing is going on. The US has an abysmally low investment rate. This sort of financial behavior is pathological, not something to be praised.
3) There’s your problem. Horseshit based on the EMH and a totally inappropriate Guassian concept of risk. What do you think Benjamin Graham would say about this?
4) That might have been true in the past, but not anymore with so much of executive compensation being in stock options. Buying back shares using the corporation’s money and then exercising stock options is a fantastic way for executives to enrich themselves at the expense of the public stockholders.