Revisiting Stock Market Short-Termism

Abstract

There is a long list of negatives regarding stock market short-termism. Short-term goals are volatile and subject to sudden fluctuations in the economic, political, and social context. In the long run, this volatility can discourage management continuity and cause firms to lose track of their strategic business models. Also, it may become more difficult to communicate leadership values within the organization if the direction followed by business leaders is continuously corrected to pursue new short-term projects; valuable employees may grow increasingly dissatisfied and decide to leave. Moreover, the pressure on executives to meet quarterly earnings may induce them to search for internal costs to reduce and externalize. For example, to avoid any market disappointment about financial results, the CEO of a chemical firm may decide to forgo a project to upgrade its plants with a state-of-the-art pollution-control system; in practical terms, the cost of that upgrade is transferred to the environment and our society at large, and will be paid by future generations. Finally, because of the pressure to deliver immediate results, senior managers may decide to manipulate corporate accounts, contributing to the credibility crisis the securities market has been suffering from in recent years.

This paper argues that the time is ripe for a concerted effort to tackle the issue of stock market short-termism. In fact, it appears that, at no other time in the long debate on the issue, have there been as many factors militating for change. These factors, detailed in six separate sections of the paper, include:

- The recognition by the business community of the need to restore investors' confidence and the credibility of the international capital markets

- The recent focus on corporate governance of the shareholder activism movement

- The pressure put on companies by investors, regulators and the judiciary, as well as rating agencies and proxy advisors to revisit the pay-for-performance issue and devise compensation schemes based on a more balanced combination of financial and extra-financial indicators of performance

- The debate on how to enhance corporate reporting based on true value of business success

- The recent empirical findings on the linkage between sustainability (i.e. environmental, social and corporate governance) factors and improved stock price and shareholder value

- The unprecedented effort undertaken by regulators, intermediaries and institutional investors to focus financial sell-side research on long-term corporate value

For the reasons explained in the paper, any effort to address the problem of short-termism should involve each link of the short-termism chain: the corporate link, the investor link and the reputational intermediary link. The paper discusses in details a number of governance and investment practices that could be supported by each of those communities to contribute to finding a solution to the problem. Suggestions for further research are also included.

Keywords: short-term, long-term, earnings, pay-for-performance, activism, sustainability, financial analysts, risk management