Challenging Industry Norms: Schapiro, Krawcheck Examine Perils of Short-Termism (Video)
When the State Street Center for Applied Research released The Influential Investor: How Investor Behavior is Redefining Performance last year, it examined the forces that will shape the future of the investment industry. As part of its Challenging Industry Norms series that debates critical issues facing the investment industry, CFA Institute teamed up with State Street to take a closer look at whether misaligned interests are transforming the investment profession.
A lively discussion exploring the pernicious effect of short-termism on investor behavior, corporate management incentives, and societal consequences was the highlight of the first panel discussion. Former SEC Chair Mary Schapiro and veteran Wall Streeter Sallie Krawcheck debated causes and effects of short-termism in the session, moderated by Wall Street Journal Money & Investing Editor Francesco Guerrera.
We shouldn’t be surprised by short-termism in the capital markets, suggested Schapiro, citing examples from our culture ranging from ubiquitous 140-character communications to the tendency of our political systems to patch over problems rather than engage in longer-term solutions. But the persistence of a short-term perspective in the financial markets was a significant factor in the global financial crisis, as Krawcheck noted, calling it a “corrosive element” for investors trying to progress towards retirement goals. Both Krawcheck and Schapiro agreed that risk is deemphasized in favor of an unhealthy fixation on returns when time horizons are short, creating dysfunctional incentives for action on the part of both investors and corporations that are in the long run distinctly unhealthy.
Francesco Guerrera challenged the panelists to consider how companies and investors can resist the lure of short-termism; as Krawcheck related, resisting the temptation to lock in attractive short-term returns is difficult, even if the tactics required (leveraging up the corporate balance sheet, for example) imply longer-term risks. Both Krawcheck and Schapiro cited the need for companies to actively seek diversity of perspective and expertise in management and on boards as a way of avoiding the “groupthink” that creates what Schapiro termed an “echo chamber” that fails to adequately challenge assumptions underlying corporate strategies. Incentives also play an important role, with Krawcheck suggesting consideration of executive compensation schemes that mirror a company’s capital structure rather than assuming that equity grants create appropriate incentives.
Investors have responsibility for resisting short-termism as well and exerting their privileges and responsibilities as owners of portfolio companies. Looking beyond simplistic measures (such as return on equity) to consider volatility as well as return would help frame corporate decisions in a more useful light. Schapiro recommended that institutional investors in particular make full advantage of the proxy process to make boards more responsive to investor interests.
CFA Institute has engaged on the issue of short-termism frequently over the years, beginning with our collaboration in 2006 with the Business Roundtable Institute for Corporate Ethics and publication Breaking the Short-Term Cycle. In the aftermath of the financial crisis, attention is intensifying on the relations between companies and investors, and the appropriate time horizons for each. But, as the State Street Influential Investor report notes, the misalignment of interests between short term and long term persist and continues to drive decisions that are less than optimal. Short-termism will remain an area of focus for our research and policy activities at CFA Institute.
Photo credit: @iStockphoto.com/Nikada