Matt Orsagh, CFA,
takes a new look at short-termism in the report
Revisited: Improvements Made and Challenges in Investing for the
Long-Term. The numbers don’t lie.
that financial markets are too short-term in nature is an issue as old
as, well, financial markets. You can go back to the Tulip Mania in the
Netherlands in the 1630s to find one of the most famous instances of
short-term speculation getting out of control and ending in ruin for
many market participants.
then are the same today. Investors, policy makers, and corporate
issuers all voice various complaints that financial markets too often
are short-term in nature and do not give companies enough time to
establish long-term sustainable strategies.
indeed the concern in 2006 when CFA Institute met with a panel of
experts and devised recommendation to help investors and companies
act, invest, and manage for the long term. We published the report “Breaking
the Short-Term Cycle” in which we made the following
earnings guidance practices.
long-term incentives across the board.
leadership in shifting the focus to long-term value creation.
communications and transparency.
broad education about the benefits of long-term thinking.
intervening years, a lot has happened in the battle against short-termism.
In that time, the company Focusing Capital on the Long-Term (FCLT) has
sprung up to focus on the issue exclusively. According to a recent
FCLTGlobal report, a significant number of companies in the United
States have jumped off the earnings guidance treadmill and have
stopped giving quarterly earnings guidance. According to the
FCLTGlobal report “Moving
Beyond Quarterly Guidance: A Relic of the Past,” published
in October 2017, the share of S&P 500 companies issuing quarterly
guidance declined from 36.0% in 2010 to 27.8% in 2016. Of these
companies, 31.4% give annual earnings guidance, and 40.8% give no
earnings guidance whatsoever.
compensation practices, however, have improved. Corporate governance
improvements, such as, say, on pay voting, has led to increased
engagement between companies and investors and to better transparency
around executive pay.
the issue of short-termism, we again put together an expert panel of
investors, issuer representatives, and other associations to
understand the issue of short-termism today.
revisiting the topic of short-termism with another set of
distinguished panelists, CFA Institute adopted four new
recommendations for market participants:
investors should focus their engagement on long-term strategy and
agreed upon metrics that drive that strategic success as
substitution for stepping away from earnings guidance.
investors should work to simplify executive compensation plans so
that incentives better align with those of shareowners and are more
investors should both make meaningful investments in engagement to
foster increased discussion around the long-term issues most
important to a company’s strategy.
investors should establish better standards around ESG data so that
the data are consistent, comparable, and auditable as well as
agreed that executive compensation has improved, but the investors we
talked to shared the complaint that too often executive compensation
is overly complicated when it doesn’t need to be. In the worst
instances, compensation seems reverse engineered to arrive at a
difference between our analysis of short-termism in 2006 and the state
of short-termism in the markets today is the emergence of ESG or
sustainable investing. Most of those we talked to in researching this
report agreed that the emergence of ESG analysis and the inclusion of
sustainability key performance indicators in the investment process
has forced investors and companies alike to focus more on the material
ESG metrics that drive long-term value. The panelist agreed that we
are in the early days of ESG integration. They were, by and large,
hopeful that this development could help focus all market participants
on more long-term management and analysis as most ESG issue tend to be
long-term in nature.
numbers don’t lie
To take a
more quantitative approach to the issue of short-termism, CFA
Institute partnered with Fund Governance Analytics for this report. We
examined the data from 1996 to 2008 to better understand whether
companies have been acting too short-term in nature during this time.
numbers revealed that companies who failed to invest in research and
development (R&D); selling, general, and administrative (SG&A)
expenses; and capital expenditure (CapEx) mostly underperformed
compared with their peers in the midterm (three to five years).
Investors noticed when companies cut back on their long-term
investment and tend to prefer companies that they see are investing
for the long term.
estimated the agency costs (foregone earnings) of short-termism at
$1.7 trillion over the 22-year period covered by our analysis, or
about $79.1 billion annually. We will have to wait and see whether
lessons have been learned by both issuers and investors, and if this
agency cost of short-termism will disappear over the long term.
@ Getty Images / abluecup
About the Author(s)
CFA, CIPM, is a director of capital markets policy at CFA
Institute, where he focuses on corporate governance issues. He was
named one of the 2008 “Rising Stars of Corporate Governance” by
the Millstein Center for Corporate Governance and Performance at
the Yale School of Management.
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