If you thought “quarterly” was a simple adverb characterizing a regularly recurring activity, you may need to reconsider. A new term is making the rounds: “quarterly capitalism” – and in this context, “quarterly” stands for “short-term, myopic, greedy and dysfunctional”. In fact, the term was already invented four years ago by Dominic Barton of McKinsey and was swiftly embraced by, among others, Al Gore and Prince Charles to call for a major overhaul of current business practices of listed companies and fund managers. Recently the term has reached a new level of prominence after presidential candidate Hillary Clinton, in a series of appearances, complained that the “tyranny of the next earnings report” resulted in companies’ paying “too little attention on the sources of long-term growth: research and development, physical capital and talent”. Unsurprisingly, Mrs. Clinton’s proposed remedy consists of a mixture of higher taxes and more regulation.
While a proper discussion of the strengths and weaknesses of the capitalistic economic regime prevailing in the Western world is clearly beyond the scope of this blog, the ongoing debate asks for some qualifications.
Good long-term, evil short-term?
First: The attack on what has been dubbed “quarterly capitalism” rests on the unproven premise that long-termism is necessarily good, while short-termism is evil. This view is confused: whether decisions are right or wrong is not necessarily related to the frequency of making and revising them. Obviously, erratic hyper-activity and changing the business model every other week will unlikely result in a sustainable and profitable business. However, neither will following a long-term strategy that is all wrong.
Second: The empirical evidence regarding short- vs. long-termism is mixed. Of course, everybody can tell anecdotes about hugely successful long-term strategies, but it is equally easy to name many failed long-term strategies. Larry Summers, although generally sympathizing with the critics of quarterly capitalism, points to General Motors, for example, which was a poster-child of long-term strategic thinking – before it had to be bailed out by the US government.
That said, there is evidence that newly listed companies are less innovative than their unlisted peers. But these differences may be telling us more about when companies, in their development, choose to go public, rather than about the negative impact of stock markets. There is also some evidence that privately owned companies invest more and pursue longer-term strategies than public companies, but a convincing explanation why – despite the long-term focus of private firms – practically all main industries are dominated by public players is rarely provided.
Third: The negative effects of investor pressure on management tend to be overrated, while the negative effects from a lack of shareholder pressure are neglected. Again, Larry Summers provides an example in pointing to the unconvincing performance of the Japanese system of cross-shareholding that was designed to protect management from shareholder pressure. Closer to home, every Austrian citizen remembers the country’s state-owned industries, which – free from any serious shareholder pressure – burned billions of state support before their privatization in the 90s.
Fourth: The short-term focus of investors and their assumed greed for dividends and other forms of payouts is generally exaggerated. Take the biotech sector for example, which has been trading on a dividend yield of under 0.5% and an earnings yield of 2% – and still has been among the best performing sectors in recent years. Or take Amazon, which has been described as “a charitable organization being run by elements of the investment community for the benefit of consumers”. The company, so far, has never returned any money to shareholders due to the lack of profits, but its market capitalisation is US$245bn. In fact, investors are prepared to go a long way in supporting long-term growth stories despite the lack of immediate cash returns. Often, those commentators who are bragging about investors’ short-termism are the very same people who warn about the next emerging bubble whenever investors buy into stocks lacking any near-term cash flows or dividends.
Fifth: As far as the negative correlation between corporate investments and payouts to shareholders is concerned, it is far from clear in which direction causation works. Some argue that “a dearth of profitable uses for capital is driving payouts to shareholders.” There is an ongoing-debate mostly among US economists about the threat of secular stagnation and a slowdown in productivity growth. Management – it seems – is facing a lack of investment opportunities in an over-regulated, mature domestic economy, and at the same time is being confronted with a slowdown in emerging markets, which have been driving global growth in the first decade of the century. Thus, nobody should be surprised when money is returned to shareholders instead of being wasted in investment projects with mediocre return perspectives.
Sixth: The attack on quarterly reporting, which is often a by-product – and sometimes the core – of the usual laments about short-termism are not convincing. Typically, they misunderstand the purpose of regular financial reports; they fail to explain why less frequent reporting will limit the noise around earnings releases; and they ignore the risk of rising insider trading if data about operations and financials are released less frequently. Most importantly, the critics of quarterly reporting fail to provide a reason why, from a principal-agent perspective, with an ever-growing amount of short-term information available to and used by management, the information of shareholders should be less frequent.
Finally, the attack on short-term trading, which often – like in Hillary Clinton’s recent speech – comes in tandem with the critique of short-termism, are – well – short-sighted. As Sebastian Mallaby recently pointed out, short-term traders “make money by pushing prices to their reasonable level after a disturbance: for example, a large sale by a sovereign wealth fund. This stabilising function helps other market participants, including long-term investors: it ensures that they will get a fair price for their shares whenever they sell them.” Moreover, it is worth mentioning that a significant share of a typical fund manager’s trading takes place in response to regulation, i.e. to avoid violations of legal and fund-specific investment restrictions.
Right balance between short-term and long-term investors needed
Bottom-line: It goes without saying that aspiring to do the right thing over a long period is a desirable attitude – both in private life and in business. However, as a recent research piece from Credit Suisse (“A Long Look on Short-Termism”) pointed out “there are some legitimate reasons for the shortening of time horizons”, including shorter asset lives, on average, in the corporate sector.
At Erste Asset Management it is one of our key goals to identify companies that follow a sound and successful longer-term strategy, and we make every effort to look “through” short-term market volatility and the noise that sometimes surrounds quarterly earnings releases. We understand Warren Buffet, who famously quipped that his “favorite holding period is forever”. However, we are also aware that a) fundamentals of companies often change; b) investors in our funds decide, for a good reason, to give us more or to withdraw money; or c) our assessment of a company’s future– yes, it can happen – was less than perfect. Therefore, also for long-term investors there are many good reasons to trade. Then, the presence of short-term traders and investors helps, while new taxes and regulations don’t.