Long-term Thinking: Capital for the Future

SHENG Fangyuan

Keynes didn’t expect that his words “In the long run, we are all dead” would have so many advocates now, though, this time, we are talking about a different topic. Short-termism, a myopia that enjoys short-term payoff on the expense of long-term gains, is no longer new in the daily business.

In 2016, Aspen Institute and McKinsey & Company showed concerns about the phenomenon: at top 400 American public companies, around 80 percent of their managers admit that they would sacrifice company’s long-term value for the quarter’s earnings target.[1] Similar situations are observed in Europe, China, Russia and other countries. In the modern society of today, environmental awareness and the calling for sustainable development still fail to protect us from the lure of the short-termism. As a result, many investments and activities end up causing financial, political, environmental, and social problems.

Then what can be done? Many consider financial market regulations, environmental protection campaigns, social welfare and new recourse development. However, it is much more effective to launch one comprehensive project to change the framework from scratch and GUIDE the capital in the market to good use than take hundreds of actions for remediation. The idea is to let the capital serve for the future by itself through finding the causes for short-termism and making long-term development more attractive. When decisions are made for the long run, various problems and conflicts can be avoid from the very beginning.

[1] Alana Semuels. How to Stop Short-Term Thinking at America’s Companies, https://www.theatlantic.com/business/archive/2016/12/short-term-thinking/511874/, 2016–12.

To start with, it is crucial to understand that short-termism is neither an innovation of today, nor a 100% bad thing in the inter-temporal problems. As long as we are still human beings with bounded rationality, short-termism will be our company, more or less. After all, it is not easy to think in the future while living in the present. The key is not about making choice between short-term and long-term, but finding the balance of the two.

On the causes of current excessive short-termism, one possible explanation goes to materialism and fast-paced urban culture. Nevertheless, this is only the tip of the iceberg. With improved market, financial innovations, regulations and better-educated participants, things are supposed to be better, aren’t they? But why do more and more people fall into the trap of short-termism? Why does the problem intensify now?

In fact, many companies’ short-termism is not out of their will. This could be partly attributed to their short-sighted investors (Laverty 1996). For these investors, “beautiful” quarterly issued numbers and rising stock prices have the final say. As expected, managers have no choice but to sign their names on the projects of instant payoff and highest profit to please the board of the directors and investors. After all, who would like to put their job at risk for the “goodness” of the far future? In addition, what makes things worse is that this investor-related myopia is not a one-way street, but an interactive and reinforcing process: the company with a short-sighted manager is more likely to attract short-sighted investors (Brochet 2012). A vicious cycle.

However, the blame on the cultural factors and the pressure from investors is not the whole story. A deeper reason might be the lack of public confidence about the future. People are worried. When the future is gloomy, short-term thinking prevails: why should I wait for another 5 years instead of getting the money right now if the situation will be even worse? What’s the point of caring about the environment and social problems if I can not see the future of my own? In other words, excessive attention to the present means excessive uncertainty in the future. And this is not something out of blue. Slack demand and sluggish market all over the world, yellow vests in the Champs-Elysees Avenue, wall on the border of USA and Mexico, anti-refugee protests in Germany and Sweden, Brexit in the coming year…… Financial bumbles, political conflicts, as well as social instability, unnerve everybody. Without a stable and secure investment environment, it is hard to convince investors to put their money aside for the future and invest in the long run. Therefore, creating a good investment environment is of significance.

Knowing the main causes, we are able to find the solution — — a package plan to establish a stable and long-term oriented social and market system with the cooperation among governments, companies and individuals.

Governments:

1. Political and Social Reform

Economic problem is never merely economic. It twists with political, cultural, and social problems. Short-termism gives us a glimpse on investors’ worries about the future. If a majority of investors lose confidence on the market, a global recession is inevitable. To this extent, sending political and social reform signals for safe and promising future will be the “cardiac stimulant” to the economy and fundamental solution to the short-termism. For instance, the government could make investment in business, initiate projects to mitigate social and political problems and, most importantly, make the plan available to the public so as to reduce the uncertainty of the economy.

2. Economic Incentives and New Pricing & Valuation System

When it comes to attract long-term capital, some economists suggest establishing a long-term stock market. Experiment has been made but end up unsatisfying result. The problem lies in the way we define a long-term investment. It is not as simple as calculating “the holding period of a shareholder” since long-term information based decisions can lead to a short-term sell as well (Edmans 2017). A better method is to examine whether he or she makes the decision on the long-term information. Thus, it is quite urgent to make more long-term information available for long-term investment without discouraging short-term trade.

① New Long-term Metrics in Reporting and Accounting

Thomas Bayes’ theory of prior distribution and posterior distribution lays the foundation for the modern investors’ expectation on financial products. Expectation will be revised accordingly when new information arrives. Price changes once expectation changes. That is how information influences the market. Short-term information also plays an important role in price setting but the concept of making decision solely on quarterly data is a monster. In the attempt to reverse the trend, a simple and straightforward idea is to make long-term index “visible”.

Releasing new long-term data in exchanges like NASDAQ helps to switch the public focus to the long run. On the one hand, re-design the current trade table of the exchange by adding long-term indexes such as R&D investment and net profit in the past 10 years. On the other, make it compulsory for all the financial platforms and software to include long-term index.

Further, anti-short-termism calls for revision on reporting and accounting system. Currently, R&D is the main index for long-term investment measurement. But that is nowhere near enough. In accounting, for example, environmental and social contribution and related expense are recommended to be added into companies’ intangible asset. And other new metrics for company’s performance evaluation and long- term investment measurement deserve scholars’ study.

② Floating Discount Rate System

Price is the key of the market. All market participants are sensitive to price. Existing asset pricing system is mainly based on the method of discounting future cash flow by a given rate of return. This discount rate shows the value of the time, namely, one dollar today is more valuable than one dollar tomorrow. But things will be different if less discount rate is assigned to the future cash flow. Suppose a company has a cash flow of 1 million in the coming 3 years and 3 million in the 4th year. Let us have a look at how floating discount rate system influences the stock price.

Given a constant discount rate of 5% for all 4 years:

Given a declining discount rate of 5%, 5%, 4% and 3%:

Less discount rate for the cash flow, higher the stock price. In this way, floating discount rate re-evaluates the importance of cash flow that happens in different time. Once a proper discount rate is given, it would be costly to ignore the future cash flow, which greatly encourages long-term investment.

③ Tax Exemption for Long Term Shareholders

The longer the term, the less the tax. For example, shareholders who hold the stock for more than 1 year can enjoy tax exemption on his capital gains income or in other process during the trade. Meanwhile, special tax exemption fund needs to be raised ahead so as to replenish the budget without influencing government’s daily activities.

Less discount rate for the cash flow, higher the stock price. In this way, floating discount rate re-evaluates the importance of cash flow that happens in different time. Once a proper discount rate is given, it would be costly to ignore the future cash flow, which greatly encourages long-term investment.

Companies:

1. New Incentive and Assessment Mechanism

If the incentive and assessment system is short-term oriented, how could it be possible to encourage managers to think in the long run? Indeed, profit is often the driving force of running a company. But in many cases, short-term profit goes against long-term development. A good incentive system shall make managers feel “safe” and “confident” even if they have to make long-term decisions that might hurt the short-term profit. One plausible method is to add a parallel incentive system that gives extra points to managers if they could justify their decision by showing how it will benefit the company in the long run. Managers are supposed to be assessed by financial report and their managerial report at the same time. And contractual protection policy can also be supplemental method.

2. Term Expansion

Short managerial term causes as many problems as bad assessment system does. In the first decade of the 21th century, the average term of managers in the top 2500 listed companies declines from 8.1 years to 6.3 years.[2] And the number is even lower this decade. Managers have to show their ability in a short time period, but long-term investment takes time. Good projects might be rejected because of a long payback period. The phenomenon happens in politics too, since short-term investment makes both political achievement and corruption easier (Iconio Garrì 2010). However, if managers are in charge for a longer period, they could make long-term plans.

[2] Rappaport Alfred. Saving capitalism from short termism: how to build long term value and take back our financial future. Directors & Boards. 2011 3rd Quarter, Vol.35 issue 5, p44 — 44.1p.

Individuals:

1. Effective Dialogue With the Company and the Government

An effective dialogue is the best way to reduce information asymmetry. Different kinds of investors invest in different companies. Knowing what the company is doing now and what it will do in 10 years is crucial to investors’ investment decision. So does the dialogue with the government. Thus, individuals are encouraged to tell the company and the government about their concerns, participate in the quarterly or annual meetings and fully take advantage of the Q&A session afterwards. The more dialogues, the more information, the better understanding.

2. Self-education

For many individuals, part of their myopia comes from their value and conception as well as wrong judgement on the market and the company. Self-education for a right mindset and better judgement is the key. Joining in various education programs helps all market participants to better comprehend the status quo.

To conclude, excessive short-termism is a complicated problem asking for more public attention. The project emphasizing social stability, market confidence and long-term thinking is necessary. Raising fund for financial incentives, seeking advice from scholars on upgrading existing financial report and pricing system, creating new incentive mechanism for managers, and initiating education programs for individuals, all help to guide the capital to its new purpose. Challenges and opportunities are two sides of one coin. It’s time to slow down and think in the long run. As long as most people invest and work in a sustainable way, the capital will go to the right place to serve for a better future and work miracles!

Bibliography

[1] Alana Semuels, How to Stop Short-Term Thinking at America’s Companies, https://www.theatlantic.com/business/archive/2016/12/short-term-thinking/511874/, 2016–12.[2] Alex Edmans. The Answer to Short-Termism Isn’t Asking Investors to Be Patient [J]. Harvard Business Review, 2017(6).

[3] Dennis Carey, Brian Dumaine, Michael Useem and Rodney Zemmel. Why CEOs Should Push Back Against Short-Termism. Harvard Business Review, 2018–05–31.

[4] Francois Brochet, George Serafeim, Maria Loumioti. Short-Termism: Don’t Blame Investors [J]. Harvard Business Review, 2012(6).

[5] Iconio Garrì. Political Short-termism: a Possible Explanation [J]. Public Choice (2010) 145: 197–211.

[6] Kevin J. Laverty. Economic “Short-termism”: The Debate, The Unresolved Issues, And The Implications for Management Practice and Research [J]. Academy of Management Review, 1996, Vol. 21, No. 3, 825–860.

[7] Lucian A. Bebchuk. The Myth That Insulating Boards Serves Long-term Value [J]. Columbia Law Review, Vol. 113, No. 6 (OCTOBER 2013), pp. 1637–1694

[8] Miguel Padro. 5 Things All Voters Should Know about Combatting Economic Short-Termism.https://www.aspeninstitute.org/blog-posts/5-things-all-voters-should- know-about-combatting-economic-short-termism/ 2015–08–11.

[9] Rebecca Darr, Tim Koller. How to Build an Alliance Against Corporate Short-termism.https://www.aspeninstitute.org/blog-posts/how-to-build-an-alliance-against-corporate-short-termism/ 2017–01–30.

[10] Rappaport Alfred. Saving capitalism from short termism: how to build long term value and take back our financial future. Directors & Boards. 2011 3rd Quarter, Vol.35 issue 5, p44–44.1p.

[11] William H. Donaldson. Speech by SEC Chairman: 2005 CFA Institute Annual Conference. U.S. Securities and Exchange Commission, 2005–05–08