DISCUSSION Crippling short-termism – the real issue is still being avoided

by Yolanda Villafuerte _______19th December 2012
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(Image credit – William Warby)

The real issue on short-termism – the preference of shareholders in UK public companies for high dividends today versus the national interest of adequate investment for the long term – is still not being addressed. The Kay report and its follow-up, and, so far, discussions on Capital Markets instigated by Tomorrow’s Company, have failed to tackle this key issue.

Over the past 20 years short-termism, under-investment in the long term, has been further cemented into the fabrics of the City and Wall Street, not least by the dominance of markets by hedge funds seeking quick returns, and the tilting of markets away from investment-friendly by extraordinary levels of short-selling (betting against companies).

Crippling short-termism, system-wide in the UK and US, means that public companies are doomed by their declining ability to compete with companies from Germany and Japan, and from surging Asian countries like South Korea and Taiwan. The UK then loses employment, technological potential and skills, with wider effects on suppliers, creditors, customers and communities.

Recommendations of “soft” solutions, like more emphasis on the long term in reporting and in managerial incentives, have been irrelevant against the preference of UK and US shareholders for dividends or share-buybacks.

“Hard” measures, taxes and bans, are needed to switch shareholders to backing long-term investment. An international scoreboard should be reintroduced to check progress.

Background

Thirty years ago, an FT journalist wrote that, if the UK continued to give preference to dividends over R&D, whole industries would disappear. In 1990 I wrote “Innovation; City Attitudes and Practices”, which led to a major conference (John Kay was on one of our three panels). I also introduced the R&D Scoreboard to check how UK companies R&D, capital expenditure, and dividends compared with other countries, and wrote a paper “Promoting Long-termism”.

The City hired a business school professor, supported by a team of six fund managers, to argue that short-termism was “perceived” rather than real. Short-termism, with dividends dominating long-term investment, has since run unbridled for over 20 years in the UK. Under-investing UK public companies like GEC and ICI, and scores of others, have gone to their inevitable graves.

In the USA, there have been five major investigations/reports over the last decade. The likes of Warren Buffet have bemoaned system-wide short-termism. Dominic Barton, the global head of McKinseys, has cursed “The Tyranny of Short-termism”, claiming that the vital factor of the advancing Asian companies is that they think and act long-term.

Short-termism becomes even worse

Short-termism has been further “cemented” into the fabrics of the City and Wall Street, by four factors:-

–          Company executives have given up opposing short-termist shareholders , and have joined them in looting companies – through rocketing remuneration and lucrative exit deals;

–          Short-termists dominate market activity; IMA figures show hedge funds account for 37%, high frequency traders 28%, proprietary trading 7%, retail 4%, and long-only investors 24%;

–          “Responsible investors”, like pension funds and insurance companies, are much less important, with their ownership of UK shares falling from 52% in 1991 to only 14% in 2010;

–          The balance of the market has changed dramatically; short-selling (betting against companies) now accounts for 30 % of market activity; 15 years ago shorting was trivial, in what were then much more “investment friendly” long-only markets.

Levels of long-term investment the key issue

The one great virtue of the Kay Report is that it (finally) recognises that short-termism, under-investment in the future, is a problem in UK equity markets. But Kay fails to “follow through” with the recommendation of an international scoreboard to monitor how UK companies compare. (Such a recommendation would have embarrassed the Coalition, which in 2010 closed down the publication of the R&D Scoreboard).

Shareholders in UK companies love short-termism 

Five years ago I persuaded officials to release data on dividends collected for companies in the R&D Scoreboard. I then compared the average levels of R&D, capital expenditure, and dividends in each sector for the UK and the Rest of Europe.

Ignoring small entries and “draws”, I found that for R&D the Rest of Europe led in 8 sectors and the UK in only 2 sectors, for capital expenditure the Rest of Europe led 19/7, but for dividends the UK led 18/4. (Money Management, December 2007). It seems that shareholders in UK public companies regard dividends as a “safe bet”, compared to investment for the long term by UK companies, perhaps already weakened by past under-investment..

But the national interest must lie in UK public companies being competitive

The loss of UK companies through under-investment hits employees, removes technological capability and skills, and harms suppliers, creditors, customers, communities and national prestige.

Effective action – taxes and bans

Tough actions are needed to place long-term investment before dividends, to allow long-termists to again dominate market activity, and to tilt markets back to investment friendly long only markets.

A tax on dividends, a ban on high frequency trading, and a ban on short selling, should do the trick.

John Chapman – December 2012

John Chapman, a former Whitehall civil servant, sparked off the last (pre-Kay) debate on Short-termism in 1990 with a paper “innovation: City Attitudes and Practices” for DTI’s Innovation Advisory Board. He also wrote the follow-up “Promoting Long-termism”, and introduced the R&D Scoreboard (published 1990-2010). Subsequently he wrote some 250 articles on finance issues, including articles on Short-termism in the Guardian and the Independent and, this year, in the Financial Times His latest articles are:-

27 May 2012 – “Time to tackle UK short-termism” (Financial Times)

29 July 2012 – “Time to tackle dividends – a sacred cow in the UK” (Financial Times).

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