There are three pieces of evidence that it might be, but none of them convince me.
One is that companies demand high hurdle rates before investing - sometimes in excess of 20 per cent.
Such high rates might, however, be good quasi-rational rules of thumb. They can be a means of correcting over-optimistic investment appraisals. And they can reflect the fact that, in an uncertain world, it can sometimes pay to hold onto one’s investment options because they might become even more profitable later. For these reasons, Ian Dobbs at Newcastle University Business School has found that high hurdle rates “are not particularly costly in terms of the per cent value loss they entail.”
A second piece of evidence comes from Mr Haldane himself, who claims that stock market investors discount future cash flows by too much.
But there might be a rational reason for this. Whereas risk rises only with the square root of time, uncertainty explodes. You might have a good idea of a company’s SWOTs in the short term. But you haven’t clue about them in the long term, because even the mightiest companies can be brought down by disruptive technical change or bad strategy: think of Nokia, GEC or RBS. And, as Bridget Rosewell and Paul Ormerod have shown, even company bosses cannot foresee these catastrophic failures. In the face of massive uncertainty, short-termism might be rational. As Michael Mauboussin of Credit Suisse says: “For many companies, a contraction in time horizon is a proper response to economic reality.”
The third piece of evidence is that companies are often punished heavily for missing quarterly earnings forecasts. Such punishment might, however, be a reasonable response to asymmetric information between chief executives and outside shareholders. Shareholders might reasonably think: if a boss can’t forecast or manage near-term earnings, what else can’t he manage?
So much for my scepticism. What about evidence? There are two big facts which speak against short-termism.
One is that if equity investors were too short-termist, they would pay too much for stocks on high dividend yields - which offer short-term cash flows - and too little for growth stocks. We’d therefore expect to see high-yielding stocks underperform because they are overpriced. But, on average, the opposite is the case: value stocks outperform. Granted, this might be because they are riskier than average. But it might also show that investors aren’t short-termist enough - that they actually undervalue near-term cash flows rather than overvalue them.
Secondly, if companies invested too little, we’d expect to see high returns on the project that do go ahead. But there’s evidence to the contrary. Some economists, such as Michael Roberts and Andrew Kliman, have shown that profit rates have been trending downwards since the 1970s. Yale University’s William Nordhaus has shown that companies make only tiny profits on their investments in innovation. And Charles Lee and Salman Arif have found that increases in capital spending lead to lower profits and lower GDP growth. All this is evidence that companies have invested too much, not too little - that they have overestimated the long-term returns to investment, perhaps because of overconfidence.
What’s at stake here is not just whether companies and investors are short-termist or not, but also the question of secular stagnation. Everybody agrees that investment has been weak for years - even before the financial crisis - in the UK and US. The question is why? Those who allege short-termism believe there are profitable projects that companies are missing because of bad management and ownership. But there’s another possibility - that there are simply very few such projects. And this is a rather scarier thought.
