Requiring less information would favour better-connected professional investors
Progressive critics and chief executives decry what they see as a myopic market’s pressure to cut back on investment and increase dividends and share repurchases
Larry Summers has written a remarkable piece in the September 3, 2018 issue of the Financial Times, which can be found here by subscription.
President Donald Trump has asked the US Securities and Exchange Commission to investigate moving public companies to a six-month rather than three-month reporting cycle to combat an excessive corporate focus on the short term.
Progressive critics and chief executives alike decry what they see as a myopic market’s pressure to cut back on investment and increase dividends and share repurchases. In her 2016 presidential campaign, Hillary Clinton proposed raising capital gains taxes for investments held for less than six years to combat short-termism.
Few ideas command such widespread support as the notion that companies should be induced to concentrate more on the long term. Unfortunately, while there are important ways in which corporate governance can be improved, the idea that a myopic market forces companies to forgo highly attractive investment opportunities is unsupported either by logic or evidence.
It is no surprise that the idea is attractive to many. Just as my students often suggest that the grading system forces them to study a particular syllabus rather than pursue their intellectual passions, managers prefer to avoid frequent accountability for results. The former chief executive of GM, Rick Wagoner, who presided over tens of billions of dollars of unsuccessful investment during the 2000s, was a leading voice against market-generated pressures for short-termism.
There is also an apparent worker interest in resisting payouts: employees at existing companies naturally prefer them to retain cash and grow, while the potential new groups that could be financed out of cash payouts do not yet have workers.
But popularity is not the same thing as validity. A variety of facts about market behaviour belie the systemic short-termism thesis. First, there are large numbers of companies, of which Amazon is only the most prominent example, that trade at huge multiples to current profits because of credible long-term plans.
There are now hundreds of unicorns — private start ups valued at more than $1bn — almost all of whom have little or no profits. This suggests that investors are happy to buy into credible, long-run corporate visions.
Second, many studies have now confirmed that companies where cash flows are highest relative to stock prices earn the highest returns. If, as the short-termism thesis suggests, these companies were over-valued, one would expect them to earn abnormally low returns rather than unusually high ones.
Third, private equity firms and venture capitalists expect companies they own to report on a monthly basis. Capable chief executives set a similar standard for divisions within their company. Otherwise they fear that problems will fester without being addressed. If companies with a sole owner in possession of a professional staff are expected to report frequently, why should not the same be true for public companies?
Fourth, companies differ greatly in their management quality. It is natural that those with better management and more opportunities will reinvest more of their profits and earn higher returns over time. To infer — as many advocates of the short-termism, including a 2017 McKinsey study, do — that this proves all companies should invest more, is to commit the obvious fallacy of confusing correlation with causation.
Reducing the frequency of corporate profit reporting would make big surprises and drastic market moves more likely. It would also allow managers to wait longer before they revealed large problems. Think of how much longer it would have taken for the issues at GE to become clear if the company reported only every six months.
Less frequent reporting would favour professional investors who are in constant touch with management over those whose information would be even more limited than it is today. In an age of big data and transparency, moving towards less would be a very odd step.
What, then, should be done? The rules limiting activists’ ability to distort corporate behaviour should be updated. More transparency on share accumulation would protect ordinary shareholders. At the same time, new restrictions should be imposed to prevent corporate activists from voting as shareholders in companies where they have divergent economic interests from other stockholders — because, for example, they used the options markets to hedge their risk.
Wise corporate leaders should give a sense of their long-term vision on at least an annual basis. Investors who insist on such information are only being reasonable.
The writer is the Charles W. Eliot university professor at Harvard and a former US Treasury secretary.