A Long Look At Short-Termism: Questioning The Premise

Short-termism is said to plague all parties in the investment community in the U.S, including investment managers, companies, and investors. But as the authors point out, proving the existence of short- termism is difficult. Convincing evidence of the stock market’s short-termism would have to come from what the stock market actually does, as opposed to what individual observers say it does. The empirical evidence produced over the years by academic research suggests that the main focus of financial markets when valuing companies is long-run profitability.

Some widely cited indications of short-termism are likely to reflect rational responses to other developments. For example, although portfolio turnover has indeed increased substantially in the last five decades, this is likely to be attributable more to deregulation and the dramatic drop in transaction costs than any change in investors’ time horizons. And in recent years, the turnover of mutual funds, a common proxy for the time horizon of institutional investors, has actually declined somewhat, reversing the previous trend.

A more careful look at investor behavior suggests that although some companies and investors exhibit short-termism, they are like partners in a dance, attracted to one another based on their characteristics. In Warren Buffett’s words, companies end up with the investors “they deserve.” The authors provide a number of suggestions—several of them involving improvements in the design of incentives—for investment managers, companies, and investors in resisting the pressures of short-termism.

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