The tyranny of the long term

THE sheep in “Animal Farm” repeat the slogan, “Four legs good, two legs bad”. In the management world these days, the chant is “Long-termism good, short-termism bad”. The Harvard Business Review constantly thunders against the evils of short-termism. Bosses of listed companies give off-the-record briefings to journalists bemoaning shareholders’ inability to see beyond the ends of their noses. In the continental European model of capitalism, long-termism means that businesses will prosper by pursuing the enduring interests of all their “stakeholders”, workers and suppliers included. More recently, supporters of Anglo-Saxon capitalism have produced a variant of this argument: firms will enjoy sustained growth if they favour the interests of long-term shareholders over traders who hold stock for briefer periods.

This is not merely rhetoric. Policymakers are drawing up plans to give long-term investors more shares, more voting power or tax incentives. France already has a rule that gives extra voting rights to long-term shareholders; and the European Commission is mulling something similar. The Delaware Supreme Court—which sets the tone of much American corporate law because so many companies are registered in that state—has endorsed the view that a firm’s owners are those who have held its shares for a long time (though it has not said how long), rather than those who happen to own them at any given moment.

It is easy to see why long-termism has become so fashionable. Repeated financial-market crises, including the one in 2007-08, have reinforced a view that short-term traders are nothing but trouble. Germany’s relatively strong performance over the past decade seems to be an affirmation of its stolid corporate virtues. But there is a danger in going too far.

Long-termism is no guarantee of success. In the 1980s fans of Japan’s economic model argued that it would pull ahead of America because its firms preferred slow consensus-building and could rely on their core shareholders, the banks, to stand by them for the long term. But between 1990 and 2013 the American economy grew by 75% in real terms, whereas Japan’s only managed 24%.

In 1994 Jim Collins and Jerry Porras, two management pundits, published a hymn to long-termism in “Built to Last”. The book describes 18 companies whose shares had consistently outperformed stockmarket indices over decades, in large part because they invested heavily in such things as research and training, and set goals that were also measured in decades, not quarters. But a follow-up study five years later discovered that only eight of them had kept on outperforming the market. Today many of their exemplars are struggling. IBM is treading water, Motorola is a shadow of its former self and Procter & Gamble has been forced to bring back a retired boss, A.G. Lafley, to sort it out.

Long-termism can be an excuse for failing to grasp the nettle. Nokia, a Finnish mobile-phone giant, left a floundering boss, Olli-Pekka Kallasvuo, in place for four years despite growing protests from investors. By the time it got around to replacing him in 2010 the company was damaged almost beyond repair. Short-term demands such as quarterly reporting schedules can force problems out in the open, the quicker to get them fixed. We might still be in the dark about Tesco’s accounting fiasco if the British grocer did not have to update investors on its performance every few months. More important, short-termism can allow “creative destruction” to work its magic. The United States has been better than other countries at producing world-beating startups because it is better at shifting capital quickly to new opportunities.

Perhaps the strongest argument for rewarding long-term investors is that they think more about sustained growth, whereas short-term ones will sacrifice this for a quick buck. This is true if companies do not trade in their own shares, says Jesse Fried of Harvard Law School. However, he argues that this argument breaks down when firms become enthusiastic repurchasers of their own shares, as American companies have: last year those in the S&P 500 index bought back $500 billion of their own stock.

His explanation is as follows: companies repurchase their shares when they think they are cheap, as a way of benefiting their long-term holders at the expense of those who sell. As it happens, their timing is often poor. However, what is more important is that the cash they spend on repurchases could often have been used on expanding into new markets, or on research and development, to generate long-term growth. One study found that a doubling of repurchases leads to an 8% fall in spending on R&D.

Terms and conditions

All this is not to say that we should start chanting: “Short-term good, long-term bad”. Rather, it is an argument for nuance. Long-termism and short-termism both have their virtues and vices—and these depend on context. Long-termism works well in stable industries that reward incremental innovation. But it is a recipe for failure in such businesses as social media, where firms are constantly forced to abandon their plans and “pivot” to a new strategy, in markets that can change in the blink of an eye.

Nor are long-termism and short-termism mutually exclusive. General Electric, often praised for its long-term perspective, is trying to run itself more like a startup, to combat bureaucratic bloat. In recent years activist investors have repeatedly bought stakes in big firms, from Yahoo to Fortune Brands, and agitated for a shake-up. Long-term institutional investors, seeing the merits of their arguments, have often backed them.

Making sweeping statements about the virtues of long-termism and the vices of short-termism is a satisfying pastime: it confers a sense of moral seriousness and intellectual depth. But it is a poor way of analysing the dynamics of wealth creation—and it is an even worse way of designing corporate policies.