CFA Institute takes a new look at short-termism in the report Short-Termism Revisited: Improvements Made and Challenges in Investing for the Long-Term. The numbers don’t lie.
The complaint that financial markets are too short-term in nature is an issue as old as, well, financial markets. You can go back to the Tulip Mania in the Netherlands in the 1630s to find one of the most famous instances of short-term speculation getting out of control and ending in ruin for many market participants.
The concerns then are the same today. Investors, policy makers, and corporate issuers all voice various complaints that financial markets too often are short-term in nature and do not give companies enough time to establish long-term sustainable strategies.
This was indeed the concern in 2006 when CFA Institute met with a panel of experts and devised recommendation to help investors and companies act, invest, and manage for the long term. We published the report “Breaking the Short-Term Cycle” in which we made the following recommendations:
- Reform earnings guidance practices.
- Develop long-term incentives across the board.
- Demonstrate leadership in shifting the focus to long-term value creation.
- Improve communications and transparency.
- Promote broad education about the benefits of long-term thinking.
In the intervening years, a lot has happened in the battle against short-termism. In that time, the company Focusing Capital on the Long-Term (FCLT) has sprung up to focus on the issue exclusively. According to a recent FCLTGlobal report, a significant number of companies in the United States have jumped off the earnings guidance treadmill and have stopped giving quarterly earnings guidance. According to the FCLTGlobal report “Moving Beyond Quarterly Guidance: A Relic of the Past,” published in October 2017, the share of S&P 500 companies issuing quarterly guidance declined from 36.0% in 2010 to 27.8% in 2016. Of these companies, 31.4% give annual earnings guidance, and 40.8% give no earnings guidance whatsoever.
Executive compensation practices, however, have improved. Corporate governance improvements, such as, say, on pay voting, has led to increased engagement between companies and investors and to better transparency around executive pay.
To reexamine the issue of short-termism, we again put together an expert panel of investors, issuer representatives, and other associations to understand the issue of short-termism today.
After revisiting the topic of short-termism with another set of distinguished panelists, CFA Institute adopted four new recommendations for market participants:
- Issuers and investors should focus their engagement on long-term strategy and agreed upon metrics that drive that strategic success as substitution for stepping away from earnings guidance.
- Issuers and investors should work to simplify executive compensation plans so that incentives better align with those of shareowners and are more easily understood.
- Issuers and investors should both make meaningful investments in engagement to foster increased discussion around the long-term issues most important to a company’s strategy.
- Issuers and investors should establish better standards around ESG data so that the data are consistent, comparable, and auditable as well as material.
Our panelist agreed that executive compensation has improved, but the investors we talked to shared the complaint that too often executive compensation is overly complicated when it doesn’t need to be. In the worst instances, compensation seems reverse engineered to arrive at a predetermined outcome.
The biggest difference between our analysis of short-termism in 2006 and the state of short-termism in the markets today is the emergence of ESG or sustainable investing. Most of those we talked to in researching this report agreed that the emergence of ESG analysis and the inclusion of sustainability key performance indicators in the investment process has forced investors and companies alike to focus more on the material ESG metrics that drive long-term value. The panelist agreed that we are in the early days of ESG integration. They were, by and large, hopeful that this development could help focus all market participants on more long-term management and analysis as most ESG issue tend to be long-term in nature.
The numbers don’t lie
To take a more quantitative approach to the issue of short-termism, CFA Institute partnered with Fund Governance Analytics for this report. We examined the data from 1996 to 2018 to better understand whether companies have been acting too short-term in nature during this time.
Crunching the numbers revealed that companies who failed to invest in research and development (R&D); selling, general, and administrative (SG&A) expenses; and capital expenditure (CapEx) mostly underperformed compared with their peers in the midterm (three to five years). Investors noticed when companies cut back on their long-term investment and tend to prefer companies that they see are investing for the long term.
Our research estimated the agency costs (foregone earnings) of short-termism at $1.7 trillion over the 22-year period covered by our analysis, or about $79.1 billion annually. We will have to wait and see whether lessons have been learned by both issuers and investors, and if this agency cost of short-termism will disappear over the long term.
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