The long and the short of it

March 10, 2017
Jeremy Spira
Jeremy Spira

In February, McKinsey published this paper that identifies the traits of short-term oriented companies and makes a case that companies managed for the long term perform better. The hallmarks of short-termism are, according to the paper:

  • Insufficient and inconsistent investment in capital
  • Boosting published earnings by relying on accruals and accounting methods
  • Growing margins by cutting costs, in order to meet short-term targets
  • Management oriented to meeting quarterly earnings forecasts
  • Excessive focus on analyst metrics (eg using share buy-backs to increase earnings per share) instead of fundamental value

Long-term focused companies behaved conversely. Using this basis for differentiation, McKinsey go on to show that, over the period from 2001 to 2014, long-term oriented firms invested more, grew revenue faster, added more jobs and performed better financially than other firms. At the same time, paradoxically, there was evidence of an increase in short-term behaviour, although this seems to vary by industry. Ideas-intensive industries, such as software and biotechnology, appear to be managed to a longer time horizon, whereas capital-intensive industries, such as automobiles and chemicals, are more short term. McKinsey speculate that this is down to industry profitability: larger profit pools permit the “luxury” of a longer outlook, and vice versa.

In response to McKinsey’s paper, Schumpeter, The Economist’s business columnist, suggested three problems with their analysis:

  • As evidence that short termism is overstated, Schumpeter cites the long (and increasing) tenure of S&P500 CEOs, the illusion of high share turnover created by high frequency traders, the rise of passive funds with infinite holding periods and investors’ willingness to buy long-dated bonds or factor in profits 10-years out when investing in shares such as Amazon. Schumpeter attributes the current high levels of share buy-backs to high profit levels – they are not coming at the expense of capital investment, which is as high as it has been. Warren Buffett, in his latest letter to Berkshire Hathaway shareholders, justified the case for share buy-backs when profits are large and opportunities for new investment are scarce, or have been exhausted.
  • Schumpeter also questions the commonly held belief that short-term decision-making leads to under-performance – maybe it’s the case that under-performing firms are forced to take measures (such as cutting costs and reducing shares in issue) in response to a challenging business climate.
  • The obsession with helping companies take a longer-term view is, Schumpeter tells us, a distraction from the real issue, which is that incumbents in many industries face a lack of competition. Rather than employing (supposedly long-sighted) strategies that shield management from investors’ short-term scrutiny, markets should be made more dynamic, encouraging new entrants to challenge for a share of profit.

On the third point in particular, Schumpeter’s arguments seem weak. The impetus behind the movement towards greater long-termism is not to “insulate [firms’] managers from investors”, but rather to change the dynamic of this engagement. Management without accountability to shareholders allows agency capture by the former. Most definitely, management should not be evaluated on short-term measures (changing incentive structures and compensation would help here). Instead, investors should exercise their discretion and look for investment opportunities where sustainable value is being created. And management should look to engage with investors on their long-term strategic plans.

Ultimately though, I have a point here about self-awareness. We in the Thinking Ahead Group (and, I deduce from conversations we have had, many of the TAI members) are strong advocates for long-term investing. Caught up in this mind-set, it is tempting to be dismissive of all positions that regard rallying against short-term thinking as a “distraction”. But forming a robust point of view requires humility in acknowledging the merits of opposing arguments – after all, as we try to change the status quo, they help explain the reason why things are the way they are.