Curbing Excessive Short-Termism
Date: May 2014
Type: Perspectives Paper
Background: The problem of excessive short-termism
What is excessive short-termism?
Decisions--including those of a business, investment or financial nature--are often made with a particular timeframe in mind.
Similarly, the outcomes of decisions may be assessed having regard to a pre-determined timeframe (whether implicit or explicit). The identification of a
timeframe for expected outcomes is often important because decisions made with a view to achieving certain long-term outcomes may have negative short-term consequences, and vice versa. For example, an investment decision by a company that has a relatively long payoff period may not have an immediate positive impact on the company’s market value, and may actually have a negative short-term impact.
Excessive short-termism has been variously described as “concentration on short-term projects or objectives for immediate profit at the expense of
long-term security”, “the focus of investors and managers on short-term returns at the expense of those over the longer-term”, and “corporate and
investment decision making based on short-term earnings expectations versus long-term value creation for all stakeholders”.
For the purpose of this perspectives paper:
1. “short-term” is defined as a time horizon of approximately three years or less, bearing in mind
that the meaning of “short-term” will vary across industries; and
2. “excessive short-termism” is defined as a focus on short-term objectives that disregards (whether intentionally or otherwise) the potential
adverse effect of those objectives on long-term value creation. It manifests in actions (e.g behaviours and decisions), as well as inaction.
Having short-term objectives is not, of itself, detrimental to company value. Effective company strategies will generally have short, medium and long-term elements. In some circumstances, a focus on short-term risks, results or opportunities will be beneficial, particularly in a time of rapid change or
crisis. There is also the view that the “long term is nothing but a “series of short terms” put back to back” ; that is, companies that perform
consistently well over the short-term may have a better chance of succeeding in the long term.
It is also important to note that the timeframe contemplated by the decision-maker will not necessarily be indicative of the quality of the
decision. Decisions made with a view to the long-term may not be “good decisions” and, similarly, short-term decisions may not be “bad decisions”.
Accordingly, it is important that companies manage short, medium and long-term horizons across all their decision-making, and strike a balance between these timeframes.
Some causes of short-termism are extraneous to the corporation. These include arms-length shareholding on public equity markets rather than relationship-based financing, absence of concentrated shareholdings in individual companies, a substantial rise in financial intermediaries over the last decade, and the growth of high-frequency traders and exchange-traded funds, both of which put pressure on corporations to produce short-term results.
It is submitted that there is currently an imbalance in decision-making by the leadership of major publicly traded companies, among others, in favour of
short-term perspectives and objectives due to pressure from some investors as well as short-term remuneration drivers for executives, and that a greater
emphasis on longer-term considerations is now required to achieve a sustainable balance.
Consequences of excessive short-termism
Excessive short-termism in investment and, in turn, corporate decision-making, may have significant consequences for the longer-term value and
sustainability of individual companies. Ultimately, it may lead to reduced shareholder value and returns over the longer-term, for example as a result
of:
• missed opportunities to create enduring value for the company and therefore its shareholders. Companies excessively focused on short-term
performance measures may fail to adequately consider and develop growth opportunities;
• under-investment in value-creating opportunities such as research and development. A 2006 survey of over 400 financial executives in the US found that 80% would decrease discretionary spending on such areas as research and development and advertising in order to meet a short-term earnings
target, while 55% would delay starting a new project; and
• the rejection of long-term projects, or projects with high build or sunk costs, including infrastructure and high-tech projects. The same 2006 US survey
found that 59% of executives would reject a positive net present value project if it would mean missing short-term earnings targets.
Excessive short-termism also has important consequences for public companies from a risk management perspective. For example, rewarding executives for short-term results can incentivise them to take excessive risks. Further, excessive short-termism may affect the corporate governance practices of listed companies. As the turnover of shareholdings increases, it becomes more difficult for companies to know and understand their shareholders. It may also undermine the traditional role of shareholders in monitoring companies because short-term shareholders are generally less concerned about stewardship, and less likely to engage with boards and management.
It is also a public policy issue. Potential consequences of excessive short-termism on the economy and broader society include:
• a reduction in the capacity for innovation and competitive advantages of businesses in global markets. This downside was recently highlighted in a book by U.S. economist Michael Porter of Harvard University (see U.S. section of this paper);
• the misalignment of share prices from value fundamentals leading to an inefficient allocation of capital. Undervaluation caused by focus
on only short-term financial indicators, such as quarterly earnings, or stemming from manipulative trading behaviours such as short-selling can prevent companies with potential for sustained long-term growth from receiving adequate financing;
• the potential for institutional corruption. Monetary payoffs based on short-term performance measures may lead to weaker accountability for long-term
consequences and create incentives for executives to “game society’s rules for immediate gain”;
• increased equity market volatility and uncertainty. This unpredictable “delta” factor may, in turn, further discourage long-term
investors and amplify the problem;
• investors increasingly moving to private markets – so-called “dark pools” – which allow participants to transact without displaying quotes publicly. Dark pools were originally created as venues for institutional investors to trade directly among themselves without high-frequency trading interference, and help to guard against short-term spikes in the price of a security. However, high-frequency traders are now also active inside most of the dark pools; and
• the distraction of companies from environmental and corporate social responsibility issues. Additionally, projects with a high potential for broad social impact, and which could help facilitate long-term economic growth, may be less likely to receive funding.
If excessive short-termism is left unchecked, there is some risk that it could lead to a reduction in the value of share markets over the long-term.
Furthermore, excessive short-termism and its consequences could exacerbate systemic risk. It has been argued, for example, that the Global Financial Crisis was exacerbated by excessive short-term thinking.
GNDI Recommendations
Boards should consider developing and disclosing a clear framework for managing long-term value creation and curbing excessive short-termism. Set out
below are some suggested practices, which extend beyond minimum regulatory requirements, that boards of listed companies could adopt to help foster
longer-term value creation. Importantly, long-term corporate success is likely to require that the board be committed to working with management, influencing management to focus on long-term value creation, and providing support if management face short-term pressures. It is also important to bear in mind that what is appropriate for one company will not necessarily be appropriate for another.
A long-term outlook and culture
1. Set long-term and forward-looking strategic goals, business strategies and implementation plans, and monitor performance with long-term considerations in mind.
2. Invest in activities that contribute to long-term value, such as research and development.
3. Be guided by the company’s core values and purposes to help balance short, medium and long-term priorities.
4. Build and reinforce a corporate culture that contributes to long-term value creation.
5. Reject actions that produce only short-term benefits if such actions are at the expense of the longer-term interests of the company.
6. Select directors for the board who have longer-term strategic perspectives.
7. Designate a director or committee of directors to focus on long-term issues and to be the advocate for the long-term
financial health of the company.
Engagement, communication and reporting practices
1. Effectively communicate the company’s long-term goals, strategies and achievements to
investors, fund managers and analysts.
2. Encourage reporting practices that disclose short-term performance in the context of medium and long-term
goals and strategies.
3. Supplement or replace short-term earnings guidance (such as quarterly earnings guidance) with more meaningful disclosures (for example, narratives that combine long-term strategy narratives, health metrics and integrated reporting).
4. Promote clear and transparent communications.
5. Educate the market to understand the benefits of longer-term thinking and the drivers of long-term company value.
6. Make stewardship and engagement a more attractive activity for investors.
Executive remuneration and rewards
1. Base a meaningful proportion of executive remuneration on long-term performance measures, avoiding excessive weighting of short-term remuneration.
2. Include qualitative criteria when evaluating the performance of executives.
Key Global Efforts, Developments and Resources to Curb Excessive Short-termism
Australia
The Australian Institute of Company Directors published a thought-leadership paper, “Curbing excessive short-termism: A guide for boards of public companies” in April 2013 . The paper examines the issue of "short-termism" and the impact it has on corporations, as well as offering several potential solutions for Australian boards wishing to shift planning and strategy on to a longer-term footing.
The Corporations and Markets Advisory Committee (CAMAC) that was established by the Australian Government has observed that, from a legal perspective, Australian directors are not confined to short-term considerations in their decision-making. The interests of a company can include its continued long-term well-being, though a director who acts in the short-term interests of members will not have breached his or her legal duties. CAMAC further observed that it is ultimately “a matter for companies themselves and the commercial judgment of directors how to balance or prioritise shorter and longer-term considerations”. Boards can seek to protect long-term shareholder value by focusing on longer-term goals, strategies and actions. It may be appropriate for boards to reject actions that produce only short-term financial results if such actions are at the expense of the longer-term interests of the corporation and its shareholders.
Brazil
The Brazilian corporate law states that directors and officers must act “to achieve the corporation corporate purposes and to support its best interests,
including the requirements of the public at large and of the social role of the corporation.”
The Brazilian Institute of Corporate Governance’s Code states that the mission of the board of directors is to protect and value the organization, optimize the return on investment in the long term. It also recommends that the board’s compensation structures should be different from those for the management (officers), given the distinctive nature of these two bodies and that compensation based on short-term results should be avoided to the board.
In its publication “Sustainability Guide for Companies: an Overview for Directors and Senior Executives”, the Brazilian Institute of Corporate Governance noted that “[t]he board of directors should support and back up management in the process of attaining long-term goals and in reducing negative externalities, taking care that management does not hasten short-term actions that could generate negative externalities in the medium and long term.
Canada
The Supreme Court of Canada held in its 2008 BCE decision that the directors’ fiduciary duty is to act in the best interests of the corporation. It held that
“[t]he fiduciary duty of the directors is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an
ongoing concern, it looks to the long-term interests of the corporation. The context of this duty varies with the situation at hand.”
The Canada Pension Plan Investment Board and McKinsey & Company launched a joint initiative, entitled “Focusing Capital on the Long Term” at the
Institute of Corporate Directors annual conference in Toronto in May 2013, calling on business leaders to focus their thinking and actions on long-term
value creation .
Europe (see also United Kingdom)
European economists have struggled with the issue of short-termism for generations. Classical economic theory favored a long-term approach but British
economist John Maynard Keynes famously observed that “in the long run we are all dead,” arguing in favor of a more expedient time frame for meeting needs. The Austrian economist Hayek criticized Keynes for that. Their 20th century debate has framed the dialogue in Europe and beyond during this century.
The European Commission held a public consultation to explore the challenges and opportunities related to long-term financing in the context of efforts to ensure smart, sustainable and inclusive growth in the European Union. The summary of responses can be found at: http://ec.europa.eu/internal_market/consultations/2013/long-term-financing/docs/summary-of-responses_en.pdf
The European Commission is due to issue a Communication later this year on long-term financing with a forward-looking approach, which will include a
company law package (a new shareholders’ rights directive and a recommendation on the comply or explain approach).
Malaysia
While the Malaysian Code on Corporate Governance 2012 (MCCG) does not specifically use the term “short-termism”, it does recommend that the Board should ensure that the company’s strategies promote sustainability. In discharging its fiduciary and leadership functions, it is incumbent on the Board to review and adopt a strategic plan for the company that includes its short-term performance against the backdrop of its long-term sustainability.
Recognizing that there can often be a perception held by shareholders that a company’s short-term objectives may not be well aligned with its long-term
strategies and business sustainability, the MCCG also recommends that the Board should promote effective communication and proactive engagements with shareholders by overseeing the development and implementation of a shareholders communications policy.
New Zealand
Issues of short-termism are particularly relevant to an economy underpinned by heavy reliance on production in the primary sector. It is no coincidence that public discourse on short-termism in New Zealand has a strong correlation to sustainable long-term economic development, appropriate economic models for primary production and investment in research and development. However, little formal or longitudinal research specific to the New Zealand context appears available.
The Institute of Directors in New Zealand publication “The Four Pillars of Governance Best Practice” outlines the importance of balancing short and
long-term incentives and outlooks in executive remuneration. Short-termism is also relevant to managing organisational development and growth including the relationship to corporate social responsibility, succession planning, risk management and incentive schemes.
Well-framed incentive schemes are identified as playing a part in producing benefits in the long-term interest of a company and its shareholders. Benefits
to this approach include:
• increased company efficiencies and cost controls;
• the development of an entrepreneurial and innovative attitude among employees; and
• encouraging management to function as a team in working towards the realisation of the company’s overall objectives.
The Institute of Directors in New Zealand’s “New Zealand Director Competency Framework” identifies the following attributes and competencies that are
relevant to director skills in mitigating short termism:
• “[the director] responds to and influences constructively, future focussed strategic chance management within an organisation”; and
• “[the director] aligns actions and behaviours in the boardroom to the organisations vision direction and values”. Other initiatives to combat short-termism in New Zealand include the Sustainable Business Council of New Zealand’s “Vision 2050”, which is aimed at ensuring that economic incentives and economic value are based on improvements to long-term strategic drivers rather than short term historical performance. An interesting contrast to risks relating to short-termism in New Zealand is identified in the governance approach to Maori (indigenous) economic development. A feature of the New Zealand economy is a growing Maori-owned and controlled asset base consequent on the resolution of long standing grievances with the Crown. Research in the area is nascent but iwi (tribal) governance appears to be characterised by multi-generational ownership and long term (sometimes 50 to 100 year) strategic and planning timeframes. This “horizon planning” impacts on how entities engage with stakeholders and service providers.
South Africa
The King Report on Governance for South Africa 2009 (King III) that was released in 2009 encourages companies to take a long-term perspective and
emphasizes the integration of social, environmental and economic issues, stating that boards should not make decisions based only on the needs of the
present as to do so may compromise the ability of future generations to meet their own needs. Instead, the board should ensure that it has appropriate
long-term objectives that will result in sustainable outcomes. This approach recognises that a business cannot operate in an economically viable manner over a prolonged period without due regard being had for long-term sustainability issues. The board should therefore consider sustainability as a business opportunity, where long-term sustainability is linked to creating business opportunities.
It is accepted in South Africa that boards should not take a short-term view on strategy and business impact and that shareholders should align their
expectations with this view. For this reason, South Africa has published “The Code for Responsible Investing in South Africa” (CRISA), which is applicable to institutional investors. The CRISA speaks of the effects of the Global Financial Crisis, which left most pension schemes underfunded and government debts in developed markets at unsustainable levels, to socio-economic challenges and climate change which threatens our own existence as human society. As long-term investors and fiduciaries, the CRISA notes that institutional investors have the responsibility to ensure that investment is made in a way that promotes long-term sustainability. This view is reflected in the preamble to Regulation 28 issued by the Minister of Finance under section 36 of the Pension Funds Act, 1956 which now states that prudent investing “should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character”.
One of the key themes addressed in the CRISA is the avoidance of excessive short-termism and it stipulates that an institutional investor should develop a policy on how it incorporates sustainability considerations, including ESG, into its investment analysis and activities. The matters to be dealt with in the policy should include, but not necessarily be limited to, an assessment of the quality of the company’s integrated reporting dealing with the long-term sustainability of the company’s strategy and operations. If integrated reporting has not been applied, due enquiry should be made on the reasons for this.
Thailand
According to the criteria of ASEAN CG Scorecard and Thai CG Assessment, it is recommended that companies disclose their remuneration policy/practices for its executive directors and CEO, which should include how short-term and long-term incentives and performance measures are used to encourage long-term decision making and sustainable company performance.
The United Kingdom
The most important recent UK development relating to the short-termism debate was the publication of the Kay Review of UK Equity Markets and Long-term Decision Making in July 2012. This government-commissioned report concluded that short-termism was indeed a problem for companies with a listing on UK equity markets. The problem was principally caused by a displacement of earlier trust relationships between companies and shareholders by the advent, over the last 20 years, of a more speculative investor culture based on transactions and trading.
In an effort to counter short-termism pressures, Professor Kay made a number of policy recommendations in the report:
• Improve the incentives and quality of engagement between companies and investors by establishing an Investor Forum to foster more effective collective engagement by institutional investors. This proposal has been supported by the UK Government, and its potential implementation is currently being explored by leading UK institutional investors.
• Restore relationships of trust and confidence by applying fiduciary standards more widely within the investment chain. This idea has led the UK Law Commission to initiate an investigation into the fiduciary duties of pension fund trustees and their long-term stewardship responsibilities, which is
due to report in 2014.
• Change the culture of market participants by the adoption of ‘good practice statements’ by company directors, asset managers and asset holders. These statements are intended to promote a more expansive form of stewardship and long-term decision making, and have been endorsed by the
UK Government. Such statements complement the UK Stewardship Code for institutional investors which was published in 2010 (and revised in 2012), and which defines long-term ownership responsibilities for institutional shareholders. A significant proportion of UK fund managers and asset owners have
signed up to the Code, which is voluntary in nature and is implemented according to the “comply or explain” principle.
• Realign incentives by better relating directors’ remuneration to long-term sustainable business performance and better align asset managers’
remuneration to the interests of their clients. The UK Government has sought to encourage such pay practices by advocating the deferment and potential claw back of variable pay in the UK Corporate Governance Code, the Financial Conduct Authority’s Remuneration Code for banks, building societies and some investment firms, and by introducing a binding shareholder vote on executive pay policy, which came into force in 2013.
Another of Professor Kay's recommendations was to abolish any obligatory requirement amongst listed companies for quarterly financial reporting. This proposal has won the support the UK Government, although relevant legislation in this area falls under EU law. However, on the basis of UK government support, agreement has now been reached at EU level on amendments to the Transparency Directive which will remove the requirement to publish interim management statements or quarterly reports.
Finally, in October 2013, the UK Government implemented legislation to restructure the annual report in a way that will help companies, through their
narrative or non-financial reporting, to bring the strategic messages that are valued by long-term shareholders and investors to the fore in company
reports.
The United States
The National Association of Corporate Directors (NACD) also offers constant guidance to help directors ensure long-term sustainable value of enterprises
they oversee. Notably, NACD Blue Ribbon reports on topics including performance metrics, executive compensation, and risk oversight which make the case for a longer-term perspective and practices.
One of the first US observers to call prominent attention to the problem was Michael Jacobs in his classic work “Short-Term America” . Since then, a number of scholars have taken up this cause, most recently and notably Harvard University’s Michael Porter noted in his recent new book “Competitiveness at a Crossroads” , Porter defines a nation’s competitiveness as the extent to which companies operating in the country are able to compete successfully in the global economy while supporting high and rising living standards for their average citizens. Applied to the U.S., Porter notes that some steps that reduce firms’ short-term costs, then, actually work against the true competitiveness of the United States. Short-termism then, in Porter’s view, is no less than a national economic issue—and ultimately a global one, as nations are economically interdependent.
On January 14, 2010, the US Securities and Exchange Commission (SEC) published a concept release on “Equity Market Structure” which related to a wide range of market structure issues, including high frequency trading, order routing, market data linkages, and hidden, or “dark” liquidity. It noted that
“unlike long-term investors, professional traders generally seek to establish and liquidate positions in a shorter time frame. Professional traders with these short time frames often have different interests than investors concerned about the long-term prospects of a company”.
Key Research Findings and Commentary
There have been many studies on short-termism. It is beyond the scope of this paper to review all of them. However, the following studies may be of
interest:
• UK Department for Business Innovation & Skills, ‘A Long-term Focus for Corporate Britain: A Call for Evidence’ (Department for Business Innovation
& Skills, October 2010) www.bis.gov.uk/assets/biscore/business-law/docs/l/10-1225-long-term-focus-corporate-britain.pdf
• Krehmeyer, Dean, Matthew Orsagh and Kurt N Schacht, ‘Breaking the Short-Term Cycle: Discussion and Recommendations on How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus on Long-Term Value’ (CFA Centre for Financial Market Integrity & Business Roundtable Institute for Corporate Ethics, 2006) 1 www.cfapubs.org/doi/pdf/10.2469/ccb.v2006.n1.4194.
• Bebchuk, Lucian A and Jesse M Fried, ‘Paying for Long-term Performance’ (Discussion Paper No 658, Harvard Law School, 2010)
• Haldane, Andrew and Richard Davies, ‘The Short Long’ (Speech delivered at the 29th Société Universitaire Européenne de Recherches Financières Colloquium, Brussels, 11 May 2011) www.bis.org/review/r110511e.pdf
• Salter, Malcolm S, ‘How Short-Termism Invites Corruption ...And What to Do About It’ (Working Paper No 12-094, Harvard Business School, 12 April
2012) www.hbs.edu/research/pdf/12-094.pdf
• Arnold, Mark and Orthman, Jason, “The economic costs of excessive short-termism” (Hyperion Asset Management, August 2011)
• Brandes Institute, ‘Death, Taxes and Short-term Under-performance’ (Brandes Investment Partners, 2007) www.brandes.com/Institute/Documents/BI_DeathTaxesandShortTermUnderperformance0907_US.pdf
• Trades Union Congress, ‘Investment Chains: Addressing Corporate and Investor Short Termism’ (21 December 2005)
www.tuac.org/en/public/e-docs/00/00/01/F5/telecharger.phtml?cle_doc_attach=566
• Orsagh, Matthew, ‘Visionary Board Leadership: Stewardship for the Long Term’ (CFA Institute, June 2012) 30 www.cfapubs.org/doi/pdf/10.2469/ccb.v2012.n3.1
• Committee for Economic Development, ‘Corporate Governance Practices
to Restore Trust, Focus on Long-Term Performance, and Rebuild Leadership’ (2009)
www.ced.issuelab.org/research/listing/corporate_governance_practices_to_restore_trust_focus_on_long_term_performance_and_rebuilding_leadership
• Asker, John, Joan Farre-Mensa and Alexander Ljungqvist, ‘Corporate Investment and Stockmarket Listing: A Puzzle’ (ECGI, April 2013).
• ‘The Kay Review of UK Equity Markets and Long-term Decision Making: Final Report’
(July 2012) http://www.bis.gov.uk/assets/biscore/business-law/docs/k/12-917-kay-review-of-equity-markets-final-report.pdf
Type: Perspectives Paper
Background: The problem of excessive short-termism
What is excessive short-termism?
Decisions--including those of a business, investment or financial nature--are often made with a particular timeframe in mind.
Similarly, the outcomes of decisions may be assessed having regard to a pre-determined timeframe (whether implicit or explicit). The identification of a
timeframe for expected outcomes is often important because decisions made with a view to achieving certain long-term outcomes may have negative short-term consequences, and vice versa. For example, an investment decision by a company that has a relatively long payoff period may not have an immediate positive impact on the company’s market value, and may actually have a negative short-term impact.
Excessive short-termism has been variously described as “concentration on short-term projects or objectives for immediate profit at the expense of
long-term security”, “the focus of investors and managers on short-term returns at the expense of those over the longer-term”, and “corporate and
investment decision making based on short-term earnings expectations versus long-term value creation for all stakeholders”.
For the purpose of this perspectives paper:
1. “short-term” is defined as a time horizon of approximately three years or less, bearing in mind
that the meaning of “short-term” will vary across industries; and
2. “excessive short-termism” is defined as a focus on short-term objectives that disregards (whether intentionally or otherwise) the potential
adverse effect of those objectives on long-term value creation. It manifests in actions (e.g behaviours and decisions), as well as inaction.
Having short-term objectives is not, of itself, detrimental to company value. Effective company strategies will generally have short, medium and long-term elements. In some circumstances, a focus on short-term risks, results or opportunities will be beneficial, particularly in a time of rapid change or
crisis. There is also the view that the “long term is nothing but a “series of short terms” put back to back” ; that is, companies that perform
consistently well over the short-term may have a better chance of succeeding in the long term.
It is also important to note that the timeframe contemplated by the decision-maker will not necessarily be indicative of the quality of the
decision. Decisions made with a view to the long-term may not be “good decisions” and, similarly, short-term decisions may not be “bad decisions”.
Accordingly, it is important that companies manage short, medium and long-term horizons across all their decision-making, and strike a balance between these timeframes.
Some causes of short-termism are extraneous to the corporation. These include arms-length shareholding on public equity markets rather than relationship-based financing, absence of concentrated shareholdings in individual companies, a substantial rise in financial intermediaries over the last decade, and the growth of high-frequency traders and exchange-traded funds, both of which put pressure on corporations to produce short-term results.
It is submitted that there is currently an imbalance in decision-making by the leadership of major publicly traded companies, among others, in favour of
short-term perspectives and objectives due to pressure from some investors as well as short-term remuneration drivers for executives, and that a greater
emphasis on longer-term considerations is now required to achieve a sustainable balance.
Consequences of excessive short-termism
Excessive short-termism in investment and, in turn, corporate decision-making, may have significant consequences for the longer-term value and
sustainability of individual companies. Ultimately, it may lead to reduced shareholder value and returns over the longer-term, for example as a result
of:
• missed opportunities to create enduring value for the company and therefore its shareholders. Companies excessively focused on short-term
performance measures may fail to adequately consider and develop growth opportunities;
• under-investment in value-creating opportunities such as research and development. A 2006 survey of over 400 financial executives in the US found that 80% would decrease discretionary spending on such areas as research and development and advertising in order to meet a short-term earnings
target, while 55% would delay starting a new project; and
• the rejection of long-term projects, or projects with high build or sunk costs, including infrastructure and high-tech projects. The same 2006 US survey
found that 59% of executives would reject a positive net present value project if it would mean missing short-term earnings targets.
Excessive short-termism also has important consequences for public companies from a risk management perspective. For example, rewarding executives for short-term results can incentivise them to take excessive risks. Further, excessive short-termism may affect the corporate governance practices of listed companies. As the turnover of shareholdings increases, it becomes more difficult for companies to know and understand their shareholders. It may also undermine the traditional role of shareholders in monitoring companies because short-term shareholders are generally less concerned about stewardship, and less likely to engage with boards and management.
It is also a public policy issue. Potential consequences of excessive short-termism on the economy and broader society include:
• a reduction in the capacity for innovation and competitive advantages of businesses in global markets. This downside was recently highlighted in a book by U.S. economist Michael Porter of Harvard University (see U.S. section of this paper);
• the misalignment of share prices from value fundamentals leading to an inefficient allocation of capital. Undervaluation caused by focus
on only short-term financial indicators, such as quarterly earnings, or stemming from manipulative trading behaviours such as short-selling can prevent companies with potential for sustained long-term growth from receiving adequate financing;
• the potential for institutional corruption. Monetary payoffs based on short-term performance measures may lead to weaker accountability for long-term
consequences and create incentives for executives to “game society’s rules for immediate gain”;
• increased equity market volatility and uncertainty. This unpredictable “delta” factor may, in turn, further discourage long-term
investors and amplify the problem;
• investors increasingly moving to private markets – so-called “dark pools” – which allow participants to transact without displaying quotes publicly. Dark pools were originally created as venues for institutional investors to trade directly among themselves without high-frequency trading interference, and help to guard against short-term spikes in the price of a security. However, high-frequency traders are now also active inside most of the dark pools; and
• the distraction of companies from environmental and corporate social responsibility issues. Additionally, projects with a high potential for broad social impact, and which could help facilitate long-term economic growth, may be less likely to receive funding.
If excessive short-termism is left unchecked, there is some risk that it could lead to a reduction in the value of share markets over the long-term.
Furthermore, excessive short-termism and its consequences could exacerbate systemic risk. It has been argued, for example, that the Global Financial Crisis was exacerbated by excessive short-term thinking.
GNDI Recommendations
Boards should consider developing and disclosing a clear framework for managing long-term value creation and curbing excessive short-termism. Set out
below are some suggested practices, which extend beyond minimum regulatory requirements, that boards of listed companies could adopt to help foster
longer-term value creation. Importantly, long-term corporate success is likely to require that the board be committed to working with management, influencing management to focus on long-term value creation, and providing support if management face short-term pressures. It is also important to bear in mind that what is appropriate for one company will not necessarily be appropriate for another.
A long-term outlook and culture
1. Set long-term and forward-looking strategic goals, business strategies and implementation plans, and monitor performance with long-term considerations in mind.
2. Invest in activities that contribute to long-term value, such as research and development.
3. Be guided by the company’s core values and purposes to help balance short, medium and long-term priorities.
4. Build and reinforce a corporate culture that contributes to long-term value creation.
5. Reject actions that produce only short-term benefits if such actions are at the expense of the longer-term interests of the company.
6. Select directors for the board who have longer-term strategic perspectives.
7. Designate a director or committee of directors to focus on long-term issues and to be the advocate for the long-term
financial health of the company.
Engagement, communication and reporting practices
1. Effectively communicate the company’s long-term goals, strategies and achievements to
investors, fund managers and analysts.
2. Encourage reporting practices that disclose short-term performance in the context of medium and long-term
goals and strategies.
3. Supplement or replace short-term earnings guidance (such as quarterly earnings guidance) with more meaningful disclosures (for example, narratives that combine long-term strategy narratives, health metrics and integrated reporting).
4. Promote clear and transparent communications.
5. Educate the market to understand the benefits of longer-term thinking and the drivers of long-term company value.
6. Make stewardship and engagement a more attractive activity for investors.
Executive remuneration and rewards
1. Base a meaningful proportion of executive remuneration on long-term performance measures, avoiding excessive weighting of short-term remuneration.
2. Include qualitative criteria when evaluating the performance of executives.
Key Global Efforts, Developments and Resources to Curb Excessive Short-termism
Australia
The Australian Institute of Company Directors published a thought-leadership paper, “Curbing excessive short-termism: A guide for boards of public companies” in April 2013 . The paper examines the issue of "short-termism" and the impact it has on corporations, as well as offering several potential solutions for Australian boards wishing to shift planning and strategy on to a longer-term footing.
The Corporations and Markets Advisory Committee (CAMAC) that was established by the Australian Government has observed that, from a legal perspective, Australian directors are not confined to short-term considerations in their decision-making. The interests of a company can include its continued long-term well-being, though a director who acts in the short-term interests of members will not have breached his or her legal duties. CAMAC further observed that it is ultimately “a matter for companies themselves and the commercial judgment of directors how to balance or prioritise shorter and longer-term considerations”. Boards can seek to protect long-term shareholder value by focusing on longer-term goals, strategies and actions. It may be appropriate for boards to reject actions that produce only short-term financial results if such actions are at the expense of the longer-term interests of the corporation and its shareholders.
Brazil
The Brazilian corporate law states that directors and officers must act “to achieve the corporation corporate purposes and to support its best interests,
including the requirements of the public at large and of the social role of the corporation.”
The Brazilian Institute of Corporate Governance’s Code states that the mission of the board of directors is to protect and value the organization, optimize the return on investment in the long term. It also recommends that the board’s compensation structures should be different from those for the management (officers), given the distinctive nature of these two bodies and that compensation based on short-term results should be avoided to the board.
In its publication “Sustainability Guide for Companies: an Overview for Directors and Senior Executives”, the Brazilian Institute of Corporate Governance noted that “[t]he board of directors should support and back up management in the process of attaining long-term goals and in reducing negative externalities, taking care that management does not hasten short-term actions that could generate negative externalities in the medium and long term.
Canada
The Supreme Court of Canada held in its 2008 BCE decision that the directors’ fiduciary duty is to act in the best interests of the corporation. It held that
“[t]he fiduciary duty of the directors is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is an
ongoing concern, it looks to the long-term interests of the corporation. The context of this duty varies with the situation at hand.”
The Canada Pension Plan Investment Board and McKinsey & Company launched a joint initiative, entitled “Focusing Capital on the Long Term” at the
Institute of Corporate Directors annual conference in Toronto in May 2013, calling on business leaders to focus their thinking and actions on long-term
value creation .
Europe (see also United Kingdom)
European economists have struggled with the issue of short-termism for generations. Classical economic theory favored a long-term approach but British
economist John Maynard Keynes famously observed that “in the long run we are all dead,” arguing in favor of a more expedient time frame for meeting needs. The Austrian economist Hayek criticized Keynes for that. Their 20th century debate has framed the dialogue in Europe and beyond during this century.
The European Commission held a public consultation to explore the challenges and opportunities related to long-term financing in the context of efforts to ensure smart, sustainable and inclusive growth in the European Union. The summary of responses can be found at: http://ec.europa.eu/internal_market/consultations/2013/long-term-financing/docs/summary-of-responses_en.pdf
The European Commission is due to issue a Communication later this year on long-term financing with a forward-looking approach, which will include a
company law package (a new shareholders’ rights directive and a recommendation on the comply or explain approach).
Malaysia
While the Malaysian Code on Corporate Governance 2012 (MCCG) does not specifically use the term “short-termism”, it does recommend that the Board should ensure that the company’s strategies promote sustainability. In discharging its fiduciary and leadership functions, it is incumbent on the Board to review and adopt a strategic plan for the company that includes its short-term performance against the backdrop of its long-term sustainability.
Recognizing that there can often be a perception held by shareholders that a company’s short-term objectives may not be well aligned with its long-term
strategies and business sustainability, the MCCG also recommends that the Board should promote effective communication and proactive engagements with shareholders by overseeing the development and implementation of a shareholders communications policy.
New Zealand
Issues of short-termism are particularly relevant to an economy underpinned by heavy reliance on production in the primary sector. It is no coincidence that public discourse on short-termism in New Zealand has a strong correlation to sustainable long-term economic development, appropriate economic models for primary production and investment in research and development. However, little formal or longitudinal research specific to the New Zealand context appears available.
The Institute of Directors in New Zealand publication “The Four Pillars of Governance Best Practice” outlines the importance of balancing short and
long-term incentives and outlooks in executive remuneration. Short-termism is also relevant to managing organisational development and growth including the relationship to corporate social responsibility, succession planning, risk management and incentive schemes.
Well-framed incentive schemes are identified as playing a part in producing benefits in the long-term interest of a company and its shareholders. Benefits
to this approach include:
• increased company efficiencies and cost controls;
• the development of an entrepreneurial and innovative attitude among employees; and
• encouraging management to function as a team in working towards the realisation of the company’s overall objectives.
The Institute of Directors in New Zealand’s “New Zealand Director Competency Framework” identifies the following attributes and competencies that are
relevant to director skills in mitigating short termism:
• “[the director] responds to and influences constructively, future focussed strategic chance management within an organisation”; and
• “[the director] aligns actions and behaviours in the boardroom to the organisations vision direction and values”. Other initiatives to combat short-termism in New Zealand include the Sustainable Business Council of New Zealand’s “Vision 2050”, which is aimed at ensuring that economic incentives and economic value are based on improvements to long-term strategic drivers rather than short term historical performance. An interesting contrast to risks relating to short-termism in New Zealand is identified in the governance approach to Maori (indigenous) economic development. A feature of the New Zealand economy is a growing Maori-owned and controlled asset base consequent on the resolution of long standing grievances with the Crown. Research in the area is nascent but iwi (tribal) governance appears to be characterised by multi-generational ownership and long term (sometimes 50 to 100 year) strategic and planning timeframes. This “horizon planning” impacts on how entities engage with stakeholders and service providers.
South Africa
The King Report on Governance for South Africa 2009 (King III) that was released in 2009 encourages companies to take a long-term perspective and
emphasizes the integration of social, environmental and economic issues, stating that boards should not make decisions based only on the needs of the
present as to do so may compromise the ability of future generations to meet their own needs. Instead, the board should ensure that it has appropriate
long-term objectives that will result in sustainable outcomes. This approach recognises that a business cannot operate in an economically viable manner over a prolonged period without due regard being had for long-term sustainability issues. The board should therefore consider sustainability as a business opportunity, where long-term sustainability is linked to creating business opportunities.
It is accepted in South Africa that boards should not take a short-term view on strategy and business impact and that shareholders should align their
expectations with this view. For this reason, South Africa has published “The Code for Responsible Investing in South Africa” (CRISA), which is applicable to institutional investors. The CRISA speaks of the effects of the Global Financial Crisis, which left most pension schemes underfunded and government debts in developed markets at unsustainable levels, to socio-economic challenges and climate change which threatens our own existence as human society. As long-term investors and fiduciaries, the CRISA notes that institutional investors have the responsibility to ensure that investment is made in a way that promotes long-term sustainability. This view is reflected in the preamble to Regulation 28 issued by the Minister of Finance under section 36 of the Pension Funds Act, 1956 which now states that prudent investing “should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character”.
One of the key themes addressed in the CRISA is the avoidance of excessive short-termism and it stipulates that an institutional investor should develop a policy on how it incorporates sustainability considerations, including ESG, into its investment analysis and activities. The matters to be dealt with in the policy should include, but not necessarily be limited to, an assessment of the quality of the company’s integrated reporting dealing with the long-term sustainability of the company’s strategy and operations. If integrated reporting has not been applied, due enquiry should be made on the reasons for this.
Thailand
According to the criteria of ASEAN CG Scorecard and Thai CG Assessment, it is recommended that companies disclose their remuneration policy/practices for its executive directors and CEO, which should include how short-term and long-term incentives and performance measures are used to encourage long-term decision making and sustainable company performance.
The United Kingdom
The most important recent UK development relating to the short-termism debate was the publication of the Kay Review of UK Equity Markets and Long-term Decision Making in July 2012. This government-commissioned report concluded that short-termism was indeed a problem for companies with a listing on UK equity markets. The problem was principally caused by a displacement of earlier trust relationships between companies and shareholders by the advent, over the last 20 years, of a more speculative investor culture based on transactions and trading.
In an effort to counter short-termism pressures, Professor Kay made a number of policy recommendations in the report:
• Improve the incentives and quality of engagement between companies and investors by establishing an Investor Forum to foster more effective collective engagement by institutional investors. This proposal has been supported by the UK Government, and its potential implementation is currently being explored by leading UK institutional investors.
• Restore relationships of trust and confidence by applying fiduciary standards more widely within the investment chain. This idea has led the UK Law Commission to initiate an investigation into the fiduciary duties of pension fund trustees and their long-term stewardship responsibilities, which is
due to report in 2014.
• Change the culture of market participants by the adoption of ‘good practice statements’ by company directors, asset managers and asset holders. These statements are intended to promote a more expansive form of stewardship and long-term decision making, and have been endorsed by the
UK Government. Such statements complement the UK Stewardship Code for institutional investors which was published in 2010 (and revised in 2012), and which defines long-term ownership responsibilities for institutional shareholders. A significant proportion of UK fund managers and asset owners have
signed up to the Code, which is voluntary in nature and is implemented according to the “comply or explain” principle.
• Realign incentives by better relating directors’ remuneration to long-term sustainable business performance and better align asset managers’
remuneration to the interests of their clients. The UK Government has sought to encourage such pay practices by advocating the deferment and potential claw back of variable pay in the UK Corporate Governance Code, the Financial Conduct Authority’s Remuneration Code for banks, building societies and some investment firms, and by introducing a binding shareholder vote on executive pay policy, which came into force in 2013.
Another of Professor Kay's recommendations was to abolish any obligatory requirement amongst listed companies for quarterly financial reporting. This proposal has won the support the UK Government, although relevant legislation in this area falls under EU law. However, on the basis of UK government support, agreement has now been reached at EU level on amendments to the Transparency Directive which will remove the requirement to publish interim management statements or quarterly reports.
Finally, in October 2013, the UK Government implemented legislation to restructure the annual report in a way that will help companies, through their
narrative or non-financial reporting, to bring the strategic messages that are valued by long-term shareholders and investors to the fore in company
reports.
The United States
The National Association of Corporate Directors (NACD) also offers constant guidance to help directors ensure long-term sustainable value of enterprises
they oversee. Notably, NACD Blue Ribbon reports on topics including performance metrics, executive compensation, and risk oversight which make the case for a longer-term perspective and practices.
One of the first US observers to call prominent attention to the problem was Michael Jacobs in his classic work “Short-Term America” . Since then, a number of scholars have taken up this cause, most recently and notably Harvard University’s Michael Porter noted in his recent new book “Competitiveness at a Crossroads” , Porter defines a nation’s competitiveness as the extent to which companies operating in the country are able to compete successfully in the global economy while supporting high and rising living standards for their average citizens. Applied to the U.S., Porter notes that some steps that reduce firms’ short-term costs, then, actually work against the true competitiveness of the United States. Short-termism then, in Porter’s view, is no less than a national economic issue—and ultimately a global one, as nations are economically interdependent.
On January 14, 2010, the US Securities and Exchange Commission (SEC) published a concept release on “Equity Market Structure” which related to a wide range of market structure issues, including high frequency trading, order routing, market data linkages, and hidden, or “dark” liquidity. It noted that
“unlike long-term investors, professional traders generally seek to establish and liquidate positions in a shorter time frame. Professional traders with these short time frames often have different interests than investors concerned about the long-term prospects of a company”.
Key Research Findings and Commentary
There have been many studies on short-termism. It is beyond the scope of this paper to review all of them. However, the following studies may be of
interest:
• UK Department for Business Innovation & Skills, ‘A Long-term Focus for Corporate Britain: A Call for Evidence’ (Department for Business Innovation
& Skills, October 2010) www.bis.gov.uk/assets/biscore/business-law/docs/l/10-1225-long-term-focus-corporate-britain.pdf
• Krehmeyer, Dean, Matthew Orsagh and Kurt N Schacht, ‘Breaking the Short-Term Cycle: Discussion and Recommendations on How Corporate Leaders, Asset Managers, Investors, and Analysts Can Refocus on Long-Term Value’ (CFA Centre for Financial Market Integrity & Business Roundtable Institute for Corporate Ethics, 2006) 1 www.cfapubs.org/doi/pdf/10.2469/ccb.v2006.n1.4194.
• Bebchuk, Lucian A and Jesse M Fried, ‘Paying for Long-term Performance’ (Discussion Paper No 658, Harvard Law School, 2010)
• Haldane, Andrew and Richard Davies, ‘The Short Long’ (Speech delivered at the 29th Société Universitaire Européenne de Recherches Financières Colloquium, Brussels, 11 May 2011) www.bis.org/review/r110511e.pdf
• Salter, Malcolm S, ‘How Short-Termism Invites Corruption ...And What to Do About It’ (Working Paper No 12-094, Harvard Business School, 12 April
2012) www.hbs.edu/research/pdf/12-094.pdf
• Arnold, Mark and Orthman, Jason, “The economic costs of excessive short-termism” (Hyperion Asset Management, August 2011)
• Brandes Institute, ‘Death, Taxes and Short-term Under-performance’ (Brandes Investment Partners, 2007) www.brandes.com/Institute/Documents/BI_DeathTaxesandShortTermUnderperformance0907_US.pdf
• Trades Union Congress, ‘Investment Chains: Addressing Corporate and Investor Short Termism’ (21 December 2005)
www.tuac.org/en/public/e-docs/00/00/01/F5/telecharger.phtml?cle_doc_attach=566
• Orsagh, Matthew, ‘Visionary Board Leadership: Stewardship for the Long Term’ (CFA Institute, June 2012) 30 www.cfapubs.org/doi/pdf/10.2469/ccb.v2012.n3.1
• Committee for Economic Development, ‘Corporate Governance Practices
to Restore Trust, Focus on Long-Term Performance, and Rebuild Leadership’ (2009)
www.ced.issuelab.org/research/listing/corporate_governance_practices_to_restore_trust_focus_on_long_term_performance_and_rebuilding_leadership
• Asker, John, Joan Farre-Mensa and Alexander Ljungqvist, ‘Corporate Investment and Stockmarket Listing: A Puzzle’ (ECGI, April 2013).
• ‘The Kay Review of UK Equity Markets and Long-term Decision Making: Final Report’
(July 2012) http://www.bis.gov.uk/assets/biscore/business-law/docs/k/12-917-kay-review-of-equity-markets-final-report.pdf
