Are modern economies failing the marshmallow test?
Mark Haefele and Christopher Swann, UBS CIO, interrogate the benefits and failures of short term thinking.
An ability to delay gratification is considered a predictor of long-term success. In the 1960s, psychologists at Stanford 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 recently fell to a record low, according to a study by Smithers & Co. As a result, the average age of fixed asset has 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. 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, including the likes of Hillary Clinton, 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.
That said, investors are not always wrong to push back on the long-range ambitions of executives. In cases where firms have been able 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. Google’s moonshot projects lost nearly USD 1bn last quarter. A healthy balance of power between executives and skeptical investors can help ensure that funding goes to the most promising projects. And in areas where investment spending has been weak recently, this may reflect a rational concern that returns from many less pioneering projects may be constrained in a period of slower economic growth.
Nor, are high dividend payouts, which have been criticized by some opponents of short-termism, all that bad. They offer investors the freedom to put their cash in the next promising wealth-generating venture, shifting capital from companies lacking ideas toward those with better ones. And for investors who dislike the fast pace of public markets, there are plenty of options to invest in private markets – which can offer higher returns for those willing to lock up their capital for longer.
What’s more, many proposals to foster long-term thinking have potential downsides too. Penalizing short-term traders through the tax system, as some have suggested, ignores the contribution such investors make to market liquidity, which enables other participants to buy and sell quickly and at low cost, without which they may be discouraged to invest in the first place.
It is also far from certain that giving investors less information, by abolishing the requirement for quarterly reporting, as Britain’s Investment Association has proposed, would lead to more long-term thinking. Less frequent updates could merely make it harder for investors to spot problems in the accounts or strategies of publicly listed companies.
It is clear that many companies have become reluctant to invest for the long term. But the impact of that on our collective wealth is far less obvious. Marshmallow anyone?