For months now we have witnessed, and even participated in, public debate about myriad complex causes of our present economic woes. Business and government actors of all kinds have been under the spotlight and have taken the heat for acting in the short-term interests of the few, at the expense of many. Important work in areas like aligning executive compensation with long-term results could help unwind the system that has produced the results that we have now. Yet, so far, public debate has failed to highlight a point that needs more discussion and action — the relentless pressure for short-term results from some institutional shareholders, including mutual funds and hedge funds.
On Wednesday, a group of concerned Americans with deep experience in investment, business, academia and government released a statement that we hope will move the debate in the right direction. The group of 25-plus signatories includes Warren Buffett, Louis Gerstner, Peter Peterson, Felix Rohatyn, Richard Trumka and the three of us.
The statement, drafted as part of a process facilitated by the Aspen Institute Business and Society Program’s Corporate Values Strategy Group, is a call to Congress and the administration to act now to overcome short-termism and the perverse incentives that encourage shareholders to think, and act, short too often.
The statement begins, “We believe a healthy society requires healthy and responsible companies that effectively pursue long-term goals. Yet in recent years, boards, managers, shareholders with varying agendas, and regulators, all, to one degree or another, have allowed short-term considerations to overwhelm the desirable long-term growth and sustainable profit objectives of the corporation. We believe that short-term objectives have eroded faith in corporations continuing to be the foundation of the American free enterprise system, which has been, in turn, the foundation of our economy. Restoring that faith critically requires restoring a long-term focus for boards, managers, and most particularly, shareholders — if not voluntarily, then by appropriate regulation.—
Why Is Short-Termism a Problem?
It is now widely recognized that executive compensation plans that tied pay to short-term performance metrics played an unhealthy role in tempting Wall Street executives to allow their firms to load up on risky investments in order to maximize their own pay. What is less well understood is that it’s not only corporate executives and directors who can succumb to short-term thinking, at the expense of sustainable long-term value creation. Shareholders can, too, for a variety of reasons.
Short-term thinking and acting can limit the ability of business to do what it does best — create valuable goods and services, invest in innovation, take prudent risks, develop human capital, as well as address issues of social and environmental significance. A relentless emphasis on pumping up tomorrow’s stock price and meeting next quarter’s earnings target can drive the kind of dysfunctional, value-destroying behavior that we have witnessed since the fall of Enron and, on a much grander scale, in the current financial crisis.
Short-termism is not limited to the behavior of a few managers, investors or intermediaries. It is system-wide and system-driven. Corporate managers, boards, investment advisers, providers of capital and government have all played a role in contributing to short-term thinking because that’s what existing laws and regulations permit and even encourage them to do.
How to Tackle Short-Termism
If we want to restore the health and productivity of our corporate sector, it is essential that we address the problem of market short-termism in all its facets. This is obviously a big task. Nevertheless, the signatories of “Overcoming Short-Termism— have identified three leverage points for encouraging a renewed focus on long-term value creation and for addressing one part of market short-termism thus far overlooked, shareholder short-termism:
1. Market incentives: Encourage more patient capital through tax policy.
2. Alignment: Better align the interests of financial intermediaries and their ultimate investors.
3. Transparency: Strengthen investor disclosures.
It is especially important to investigate these avenues in light of the trend toward giving greater shareholder powers encapsulated in legislative proposals under consideration in the 2009 legislative session like Sen. Charles Schumer’s (D-N.Y.) “Shareholder Bill of Rights.— Institutional investors now wield substantial power — power that affects American citizens as well as global capital markets. The maturation of the institutional investor community creates both opportunity and responsibility to promote the long-term health of capital markets and, in particular, to pursue investment policies and public policies that empower and encourage business managers and boards of directors to focus on sustainable value creation rather than evanescent short-term objectives.
What Can Congress and the Administration Do?
In a Roll Call special section dated March 3, Michael Bopp and John F. Olson state: “It’s not that the authorizing committees in Congress … aren’t up to the challenge. Rather, the problem is that each committee has its own parochial turf.— Bopp and Olson were writing about financial regulatory reform; fixing corporate and investor short-termism crosses even more legislative and regulatory boundaries than financial regulatory reform.
We believe we need a national conversation among policy makers in the administration, on the Hill and in regulatory agencies so we can end the focus on the value-destroying short-termism endemic in our markets and create public policies that reward and enable long-term value creation for investors and the public good.
The task is daunting but essential if we want to promote the sustainable growth and investment returns that make for healthy corporations, healthy capital markets and healthy societies. The signatories of “Overcoming Short-Termism— are united in urging prompt and serious consideration of market short-termism, including shareholder short-termism and the role of institutional investors, and have offered a framework for beginning this conversation, which we welcome others to join.
The full text of the statement and list of all signatories can be found at aspeninstitute.org/bsp/cvsg/policy2009.
Barbara Hackman Franklin is a former secretary of Commerce and chairwoman of the National Association of Corporate Directors. David H. Langstaff is chairman of the advisory board of the Aspen Institute Business and Society Program and founder and former CEO of Veridian Corp. Charles O. Rossotti is the former U.S. Commissioner of Internal Revenue and co-founder, former chairman and CEO of American Management Systems Inc.