Andy Haldane again. He has made it a nice habit of giving papers which are amazingly insightful.
In this speech/paper, he along with Richard Davies discuss the effects of short-termism in investment decision-making. Because of lack of time, am not able to discuss the paper in details. The summary is here as well.
Drawing on evidence across time and industrial sectors, they argue that short-term behaviour is significant among investors in capital markets and is rising over time. They present some nice insights from history to present and conclude:
“This evidence – anecdotal, survey, quantitative – is broadly consistent with popular perceptions. Capital market myopia is real. It may be rising. For at least some of the jury, however, it remains inconclusive”.
They draw on a sample of over 600 firms in the UK and US over the period 1980-2009 to understand this growing short termism using the simple NPV formula. The tests assess whether expected future cash-flows paid by a company are discounted “excessively” in the determination of their share price today.
The empirical tests suggest there is significant evidence of short-termism, or “excess discounting”, among UK and US companies over the past few decades. So, either people put higher discount rates or want quicker payback periods.
This short-termism leads to two implications for investments:
- First, some projects with a positive net present value might be rejected because future cash-flows are discounted too heavily, reducing investment and ultimately growth.
- Second, long-duration cash-flows and projects are penalised particularly severely by excess discounting. Under rational discounting, cash-flows even 50 years ahead retain more than 1% of their face value. Under myopia, cash-flows have lost more than 99% of their value within 25 years.
In other words, “The long is dramatically shortened.”
This is a market failure as long-term projects and positive NPV projects are rejected. It is a market failure. What are the solutions?
- Transparency in firms highlighting long-term performance
- Improved governance
- Better compensation contract design rewarding long-term performance
- Tax / subsidy measures – tax short-term holding and incentivise long-term holdings
In the end:
Some of these initiatives have been tried and tested in differing degrees, at different times and in different countries. They have not obviously arrested the short-termism trend. It might be time to increase the level of policy ambition if the telescope is to be corrected, the voting machine socialised, the savage civilised. Public policy could help keep the plums in the pudding. Without intervention, the long could become shorter still.
Read the whole thing. It has nice explanations on how to calculate this short-termism etc in an easy manner…
However, this short termism now pertains to most of the things we do. Look at the way we are just not managing the environment especially water properly. People are just interested in their own consumption today and just not worried about tomorrow. We have forgotten many of the useful devices like rainwater harvesting etc.