An ability to delay gratification is considered a predictor of long-term success. In the 1960s, psychologists at Stanford University conducted their famous marshmallow experiment, offering children the choice between one treat now, or two if they could wait 15 minutes. The results proved an excellent proxy for future achievement, with more patient children later registering better scores on standardized academic tests, body mass, and other life measures.
On the face of it, most modern corporations appear to be flunking the marshmallow test. A wealth of data suggests that companies have become unwilling to think longer term. Capital investment by US companies as a share of cash flow fell to a record low, according to a 2016 study by Smithers & Co. As a result, the average age of fixed assets climbed to 22 years, the highest since the 1950s. Across the Atlantic, fixed investment in the UK is running at close to its lowest level since the late 1950s as a share of GDP.
So what is causing this collective myopia and is it really harming the ability of companies to generate wealth? One popular explanation for the rise in short-termism is that executives have been cowed by investors, who now prioritize hitting quarterly targets over multi-year rewards. A McKinsey survey of 400 chief finance officers found that 55% would reject a profitable project if this would cause the company to fall short of its quarterly earnings estimates by even a small margin.
One popular explanation for the rise in short-termism is that executives have been cowed by investors, who now prioritize hitting quarterly targets over multi-year rewards.
Meanwhile, companies appear to be focusing on the instant gratification of payouts to investors over the long-term rewards of investment. In 1970, GBP 10 of every GBP 100 in profit was dispersed to holders of a company’s stock. Now firms pay out closer to GDP 70.
In response to such figures, anti-short term crusaders have proposed a range of measures aimed at promoting the long view. These policies range from eliminating the requirement for companies to issue quarterly reports to rewarding investors for holding onto assets for longer with a progressively falling capital gains tax rate.
Still, a case can be made that the problems of short-termism have been exaggerated. And some of the proposed solutions may end up doing more harm than good.
For a start, short termism in business has been far from universal. The notion that companies struggle to see past the next quarterly result seems at odds with the strides that are being made in the fields of artificial intelligence, the self-driving car, and the treatment of cancer. There have been some compelling examples of business executives with the patience of saints. It took oilman George P. Mitchell over 16 years to develop the fracking technology that unleashed a global energy revolution.
Investors are not always wrong to push back on the long-range ambitions of executives.
That said, investors are not always wrong to push back on the long-range ambitions of executives. In cases where firms have been able to buck the trend, investing heavily and refusing to pay dividends, some of the resulting blue-sky investments have failed to deliver good financial returns, at least so far.