What Is Stock Market Short-Termism?
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What is stock market short-termism? It’s important to know the boundaries between stock market short-termism and other economic ills, because in public discourse many social and economic woes are mistakenly attributed to stock market myopia. But when we mistakenly categorize problems as due to corporate or stock market short-termism, when they in fact have little to do with failing to think and plan for the long run, we misunderstand the problem and miss out on the best remedies. Knowing what is, and just as importantly what is not, due to stock market short-termism is vital so that policymakers, analysts, and pundits avoid wrongly prescribing remedies that are fated for failure from the start.
In its most direct sense, stock markets are too short term if they over-emphasize immediate corporate results and discount long-term results too heavily. Critics say this affliction is severe and that distorted time horizons lead too many public firms to stop investing in good projects, to shut down work on viable R&D, and to use up cash by buying back stock even when the firm has productive ways to invest that cash. There is much empirical work estimating the extent of this core short-termism problem, and the empirical results are divided on its importance.
Some readers will balk at this view of short-termism as being too narrow. ‘That’s Type-A short-termism—it’s focused on low investment, declining R&D, and stock buybacks. But that’s not the only kind of short-termism. And not even the worst kind. Due to stock market short-term pressure, firms also degrade their workforce, pollute the environment, skirt sound regulation, damage stakeholders, cause financial crises, and risk climate catastrophe.’ Recent corporate governance efforts in the European Union have had policymakers explicitly linking stock market short-termism to sustainability failures.
This viewpoint linking stock market short-termism and sustainability failure is widely held; respected analysts seek to have large firms controlled by long-term shareholders who better appreciate the environment than short-term shareholders do. We can call this societal degradation ‘Type B Short-termism.’ In this view, as one set of analysts put it: ‘ESG is [seen as] fundamentally a time-horizon problem. (…) [C]apital markets are short-term oriented. The market rewards companies that meet quarterly earnings estimates and punishes those that miss them. (…) ESG (…) reduces long-term risk, thereby leading to future profits that are larger and more sustainable.’
But properly understood, Type B problems are not primarily time horizon problems. They should be labelled ‘Type B Social Problems,’ with the short-term modifier struck. Such corporate misdeeds are to be condemned, but they’re generally not due to truncated corporate time horizons. They are due to firms’ capacity to externalize costs and internalize profits. Firms that externalize costs in the long run are not to be applauded (for being long-run players) as compared to those that do so in the short run. When a firm pollutes this month instead of next year, its motivation could well have nothing to do with the firm’s time horizon but result from the firm’s willingness to selfishly impose costs on outsiders when rules and norms impose no counterbalancing costs on the firm. No one would conclude that a firm is sound if it has a long-term strategy of leaking toxins into the aquifer year after year or of treating employees and stakeholders badly decade after decade. The policy may be a long-term strategy but its long-term nature does not save it from reprobation. Long-term misfeasance does not and should not get a pass because it is long-term. It’s the actions’ harmful nature that’s objectionable, not their duration. Their long-term nature makes them more objectionable, not less.
In a forthcoming article, I show why this distinction is important. If we label more problems as emanating from stock market short-termism than really do spring from the stock market’s time horizon, we will think stock market short-termism is a more serious problem than it is. Mislabeling is not ‘free.’ By mislabeling the problem—as policymakers, analysts, and pundits do too often—we seek purported solutions that do not address the real problem. For example, if we think that climate change problems are due (in significant measure) to the stock market’s short-termism pushing individual companies to think about today’s profits and not tomorrow’s, then politicians will have another strong reason to adopt policies that are commonly thought to lengthen stock market time horizons. Another example: taxes on trading and lower capital gains taxes for longer-term holdings are commonly discussed as ways to lengthen stock market horizons. Stifling or at least weakening the strongest forms of shareholder pressure on executives and boards is another commonly-sought remedy sought to cure short-termism. These policies may be justified, but only for other reasons, not because it’s a shortened time horizon that propels Type B social problems. Lengthening stock market time horizons will have little or no impact on climate change, as I show in my forthcoming article. In some ways they may further damage the climate, because they turn political attention away from the hard problems that might mitigate the climate crisis—like a carbon tax—to solutions that have little or no impact—like lengthening corporate time horizons.
Mark J. Roe is David Berg Professor of Law at Harvard Law School.
A version of this post has first appeared on Columbia Law School’s Blue Sky blog (available here). The author addresses the concept of stock market short-termism and its potential conflation with externality problems in chapter 3 of Mark J. Roe, Missing the Target: Why Stock Market Short-Termism is Not the Problem (2022), from which this post and the forthcoming article draw.
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