Short-Termism at Its Worst

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday June 14, 2013 at 8:56 am
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Editor’s Note: The following post comes to us from Malcolm Salter, Professor of Business Administration at Harvard Business School.

Researchers and business leaders have long decried short-termism: the excessive focus of executives of publicly traded companies—along with fund managers and other investors—on short-term results. The central concern is that short-termism discourages long-term investments, threatening the performance of both individual firms and the U.S. economy.

In the paper, How Short-Termism Invites Corruption…and What To Do About It, which was recently made publicly available on SSRN, I argue that short-termism also invites institutional corruption—that is, institutionally supported behavior that, while not necessarily unlawful, erodes public trust and undermines a company’s legitimate processes, core values, and capacity to achieve espoused goals. Institutional corruption in business typically entails gaming society’s laws and regulations, tolerating conflicts of interest, and persistently violating accepted norms of fairness, among other things.

My argument starts by describing the twin problems of short-termism and institutional corruption and showing how the latter has led to a diminution of public trust in many of our leading firms and industries. Focusing most specifically on the pervasive gaming of society’s rules (with examples drawn from the finance industry, among others), I then explain how short-termism invites gaming and identify the principal sources of short-termism in today’s economy. The most significant sources of short-termism that collectively invite institutional corruption include: shifting beliefs about the purposes and responsibilities of the modern corporation; the concomitant rise of a new financial culture; misapplied performance metrics; perverse incentives; our vulnerability to hard-wired behavioral biases; the decreasing tenure of institutional leaders; and the bounded knowledge of corporate directors, which prevents effective board oversight.

I next turn to the question of what is to be done about short-termism and the institutional corruption it invites. In this final section of the paper, I discuss reforms and recommendations related to the improvement of board oversight; the adoption of compensation principles and practices that can help mitigate the destructive effects of inappropriate metrics, perverse incentives, and hard-wired preferences for immediate satisfactions; the termination of quarterly earnings guidance; and the elimination of the built-in, short-term bias embedded in our current capital gains tax regime.

The full paper is available for download here.

 

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