long-termism or lemons

8202019 Long-Termism or Lemons

httpslidepdfcomreaderfulllong-termism-or-lemons 123

Long-Termism or Lemons

The Role of Public Policy in Promoting Long-Term Investments

By Marc Jarsulic Brendan V Duke and Michael Madowitz October 2015

WWWAMERICANPROGRESSO



Long-Termism or LemonsThe Role of Public Policy in

Promoting Long-Term Investments




1 Introduction and summary

5 Growing signs of short-termism in public markets

7 What causes short-termism

11 Short-termism as a market failure

14 Policy recommendations

16 Conclusion

18 Endnotes

Contents



1 Center for American Progress | Long-Termism or Lemons

Introduction and summary

Te US middle class is suck in a ru Te US Census Bureau recenly revealed

ha real median household income ailed o grow beween 2013 and 2014991252he

fifh consecuive year in which i eiher shrank or did no grow1 Bu his is no jus

he sory o a weak recovery i is also he sory o a weak 2001ndash2007 expansion

Despie six years o economic growh he share o prime-age workers wih a job

ell2 and real median household income did no grow pas is 2000 level during

ha expansion3

One o he primary reasons or anemic middle-class income growh in boh pos-

2001 recoveries is a rerea in business invesmen which has remained well below

is hisoric rend (see Figure 1) Tis is especially perplexing because corporae

profis are robus and borrowing coss are hisorically low (see Figure 2)

FIGURE 1

Real growth of business investment has slowed since 2000

Log index 1960 = 0

-002

-001

000

001

002

003

004

005

006

007

008

US real business investment

1960ndash1990 linear trend

1960 1970 1980 1990 2000 2010 2015

Source Authors analysis of Federal Reserve Economic Database Gross private domestic investment Domestic business available at

httpsresearchstlouisfedorgfred2seriesW987RC1Q027SBEA (last accessed October 2015) Federal Reserve Economic DatabaseGross Domestic Produce Implicit Price Deflator available at httpsresearchstlouisfedorgfred2seriesGDPDEF (last accessed October

2015) Analysis adapted from Jason Furman Business Investment in the United States Facts Explanations Puzzles and PoliciesPrepared remarks before the Progressive Policy Institute Washington DC September 30 2015 available at httpswwwwhite-housegovsitesdefaultfilespagefiles20150930_business_investment_in_the_united_statespdf




Slow business invesmen growh predaes he Grea Recession and presens a

major challenge o boh he demand and supply sides o he US economy For

he demand side lower invesmen means ha companies are purchasing ewer

goods and services which in urn reduces employmen and wages For he supply

side less invesmen means slower produciviy growh As Whie House Council

o Economic Advisers Chairman Jason Furman has shown lack o invesmen is

he primary driver behind he recen produciviy growh slowdown4 While he

ailure o middle-class compensaion o keep up wih economy-wide produciv-

iy demonsraes ha higher produciviy does no auomaically ranslae ino

middle-class income growh5 economiss and policymakers almos universally

acknowledge ha i is sill necessary or long-erm growh in living sandards

Some policymakers and analyss have argued ha he key o increasing invesmen

is cuting axes on capial since ha would boos he incenive o save and inves in

new capial goods6

Tis argumen misses ha higher afer-ax reurns also allowinvesors o do jus as well in he uure while saving and invesing a a lower rae

Moreover ax cus hemselves can lead o higher deficis which reduce naional

saving Te balance o research on ax policy changes over he pas our decades

suggess ha lower axes on capial do no increase invesmen7 Unorunaely

he naionrsquos decades-long experimen wih ax cus or he wealhy has produced

only lackluser economic resuls a an exorbian fiscal cos

FIGURE 2

Profits have been rising while investment has been falling since 2000

Net domestic business investment and net

after-tax profits as shares of net domestic product

Source Authors analysis of Federal Reserve Economic Database Net domestic investment Private Domestic business available athttpsresearchstlouisfedorgfred2seriesW790RC1Q027SBEA (last accessed October 2015) Federal Reserve Economic Database

Corporate Profits after Tax with Investory Valuation Adjustment (IVA) and Capital Consumption Adjustment (Ccadj) available athttpsresearchstlouisfedorgfred2seriesCPATAX (last accessed October 2015) Federal Reserve Economic Database Shares of grossdomestic product Net exports of goods and services available at httpsresearchstlouisfedorgfred2seriesA019RE1Q156NBEA (last

accessed October 2015)

-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2015

Net domestic investment

After-tax profits




Tere are several public invesmens he counry could make ha would acu-

ally boos uure produciviy A robus public invesmen agenda would include

spending $100 billion per year on inrasrucure invesmen8 making college

deb ree9 and increasing amiliesrsquo access o high-qualiy child care as he Cener

or American Progress previously proposed10 Tese are imporan physical and

human capial invesmens ha would pay dividends down he road

Bu anoher challenge is moivaing he privae secor o inves when he cos

o borrowing money has never been lower11 One possible explanaion or he

15-year business invesmen drough is ha managers and invesors have become

so ocused on shor-erm profis ha hey are no making long-erm invesmens

ha will increase he value o heir companies BlackRock CEO Larry Fink

recenly wroe a leter o he CEOs o he Sandard amp Poorrsquos 500 index companies

arguing ha his so-called shor-ermism has become a real problem

As I am sure you recognize the effects of the short-termist phenomenon aretroubling both to those seeking to save for long-term goals such as retirement and

for our broader economy In the face of these pressures more and more corpo-

rate leaders have responded with actions that can deliver immediate returns

to shareholders such as buybacks or dividend increases while underinvesting

in innovation skilled workforces or essential capital expenditures necessary to

sustain long-term growth12

Tis repor examines he evidence o shor-ermism among publicly raded firms

finding ha Finkrsquos worries are well ounded I nex examines he role o hree

imporan players in modern equiy markes991252managers shor-erm raders and

insiuional invesors991252in he growh o shor-ermism

Te hrea ha shor-ermism poses o inclusive prosperiy is a orm o he ldquo lem-

ons markerdquo991252or asymmeric inormaion991252problem described by Nobel Prize

winner George Akerlo13 In a marke sellers know a producrsquos qualiy and ry o

ool buyers ino paying ull price or low-qualiy ldquo lemonsrdquo Savvy buyers reuse o

pay op dollar because doing so no longer guaranees op-qualiy producs Tis

generaes a cascading effec in which sellers who canno ge op dollar sop selling

heir high-qualiy producs unil only he low-qualiy lemons remain on he mar-ke Similarly managers o public companies know more han invesors do Since

higher shor-erm earnings signal higher long-run value some managers may

atemp o ool invesors by engaging in shor-ermism o raise curren earnings




Tis poses he danger ha invesors will believe he sock marke is a lemons mar-

ke orcing even long-ermis managers ino shor-ermism in order o appear as

profiable as shor-ermis firms aken o is logical exreme his dynamic could

cause growing firms o orgo or even exi public markes enirely

Properly uncioning markes are a powerul agen or inclusive prosperiy buproperly uncioning markes do no simply all rom he sky and canno be aken

or graned Te Cener or American Progress proposes a policy agenda ha

would nudge financial markes oward a ocus on he long erm while paying divi-

dends or managers shareholders and he middle class




Growing signs of short-termism

in public markets

BlackRock CEO Larry Fink is no he only US execuive who hinks ha pub-

licly raded corporaions are giving up long-erm value in exchange or boos-

ing curren earnings In one survey o financial execuives 78 percen said hey

would give up economic value in exchange or smooh earnings 55 percen said

hey would avoid iniiaing a very posiive profiable projec i i mean alling

shor o he curren quarerrsquos consensus earnings14 In anoher survey o more

han 1000 board members and C-suie execuives around he world McKinsey

Quarterly ound ha 63 percen el pressure o generae srong shor-ermresuls had increased over he previous five years In addiion 86 percen said

ha using a longer ime horizon would srenghen corporae perormance

including financial reurns and innovaion15

Bank o England Chie Economis Andy Haldane has poined ou several signs ha

corporae behavior is becoming increasingly shor-ermis16 in boh he Unied

Saes and he Unied Kingdom17 Firs he period an invesor holds a sock has

allen rom around six years in 1950 o less han six monhs oday18 A second sign is

a shif in firmsrsquo dividend behavior radiionally firmsrsquo dividend payou raios991252he

raio beween a firmrsquos dividends and income991252ell as ofen as hey rose Since 1980

however hey almos never all regardless o acual perormance19

A hird piece o shor-ermis evidence Haldane offers is he rise o share buy-

backs991252when firms use heir earnings o buy heir own sock and raise is price

Te 454 companies ha consisenly sayed in he SampP 500 rom 2004 o 2013

spen $34 rillion buying heir own sock accouning or 51 percen o heir ne

income Combined wih he 35 percen o ne income hey spen on dividends

ha leaves very litle or invesmen20




Haldanersquos mos rigorous piece o evidence however is a saisical analysis by him-

sel and ohers ha esimaes ldquoimpaiencerdquo across US and UK indusrial secors991252

in oher words how much markes excessively penalize a dollar o profi omorrow

relaive o a dollar o profi oday21 While Haldane and his co-auhors find no

evidence o shor-ermism beween 1985 and 1994 hey do find evidence beween

1995 and 2004 Tis poins o shor-ermism as a recen sysemic phenomenonIndeed Haldane and his co-auhors ound ha markes excessively discouned

uure earnings beween 5 percen and 10 percen per year an effec ha compounds

srongly over ime A projec ha is valued as a $56 gain over 50 years becomes an

$11 loss using he 10 percen excessive discouning Tese resuls imply ha shor-

ermis disorions are prevening companies rom making profiable invesmens

Anoher piece o evidence ha public markes have become excessively ocused

on he shor erm is a comparison beween public and privae firmsrsquo invesmen

paterns since privae firms are no subjec o he pressures o public markes

One sudy by Universiy o Caliornia Los Angeles economis John Askerand ohers ound ha US public firms inves 37 percen o heir asses while

privae firms in he same indusry and o he same size inves 68 percen22 Te

sudy also ound ha public firms are less likely o respond o a new invesmen

opporuniy Tis is especially sriking since public firms should have access o

cheaper capial which reduces he cos o invesmens Haldane and his co-

auhors have ound similar resuls among UK firms23




What causes short-termism

Tis secion examines he roles o hree differen paricipans in modern equiy

markes991252managers shor-erm raders and insiuional invesors991252in he rise

o shor-ermism I finds ha managersrsquo incenives push hem oward a ocus on

he shor erm he role o hedge unds engaging in shor-erm sraegies is more

ambiguous and insiuional invesors are a orce or long-erm ocus

Management and short-termism

Any evaluaion o he causes o shor-ermismrsquos rise mus sar wih manag-

ers hey are he ones who ulimaely make he decision o reinves earnings or

reurn hem o shareholders

Over he pas 40 years a major change in corporae managemen has been he shif

rom primarily compensaing managers wih salary o primarily compensaing

hem wih equiy eiher direcly or in he orm o opions Tis shif was a deliberae

soluion o a long-sanding issue in corporae governance ha managers are agens

acing on behal o principals991252ha is he shareholders Problems can arise when

he incenives o he agen deviae rom hose o he principal Te soluion has been

o urn he agen ino a principal by compensaing execuives mosly in sock

Unorunaely equiy-based compensaion appears o have ailed o solve he

main principal-agen problem risk-averse managers In he seminal paper on

he principal-agen problem Michael Jensen and William Meckling wroe ldquoI

is likely ha he mos imporan conflic arises rom he ac ha as he man-

agerrsquos ownership claim alls his incenive o devoe significan effor o creaive

aciviies such as searching ou new profiable venures allsrdquo Te problem is hashare buybacks and dividends are more appealing o risk-averse managers han

inherenly risky ldquocreaive aciviiesrdquo ha raise share prices in he long erm24 A

simple shif o equiy compensaion only gives conservaive managers a way o

profi more rom hese share repurchases unless pay packages are srucured wih

an acue ocus on long-erm incenives




One hing ha he movemen o reward execuives wih sock ges righ how-

ever is ha managers respond srongly o he incenives ha heir compensaion

provides In ac here is subsanial evidence ha execuives even engage in value-

desroying behavior ha hurs heir companiesrsquo overall perormance because he

execuivesrsquo compensaion provides hem incenives o do so

bull One sudy shows ha CEOs ime he release o avorable news when heir

opions ves991252hey release 5 percen more discreionary news when heir

opions ves han in prior monhs25 Tis generaes avorable media coverage

and a shor-run increase in sock price ha CEOs hen ake advanage o by

selling heir shares

bull Anoher sudy finds ha op execuivesrsquo sock ownership influenced

wheher hey increased dividends in response o he 2003 dividend ax cu26

Execuives wih large sock holdings991252meaning hey would personally benefi

more rom dividends han beore991252were more likely o increase dividendshan execuives who did no

bull Te average CFO o a large public firm believes ha 18 percen o firms repor

earnings in a misleading way27 Niney-hree percen said ha misrepresenaion

occurred because o ouside pressure o hi benchmarks 89 percen believed

i was o influence execuive compensaion and 80 percen believed i was o

avoid adverse career implicaions

bull Anoher sudy shows ha firms ha jus mee or bea analys orecass have

ar lower research and developmen growh relaive o firms ha jus miss he

orecass99125225 percenage poins less growh per year28 Te auhor suggess ha

hese firms manipulae heir research and developmen or RampD growh o mee

earnings orecass And hey have srong reason o mee hem CEOs who jus

miss earnings arges earn 7 percen less han CEOs who jus mee or bea hem

Te above evidence underscores he imporance o incenives in shaping he

behavior o managers Teir apparen responsiveness o he incenives creaed

by compensaion srucure shows ha i could be a powerul lever or improving

long-erm perormance




Short-term investors and short-termism

Anoher imporan rend in equiy markes has been he rise o insiuions such as

hedge unds ha hold large quaniies o sock bu can engage in shor-erm rad-

ing sraegies A criical debae is occurring among lawyers economiss and busi-

ness leaders abou wheher hese shor-erm raders reduce firmsrsquo long-run value

Several leading corporae governance expers including Delaware Supreme Cour

Chie Jusice Leo Srine and corporae lawyer Marin Lipon have argued ha

shor-erm ransien invesors such as acivis hedge unds991252and heir role in

corporae governance991252have been responsible or he rise o shor-ermism29

Tey have suggesed measures o curb heir influence such as giving long-erm

invesors a sronger voice in corporae governance han shor-erm invesors and

insulaing boards o direcors rom shareholder acivism

Srine and Liponrsquos main opponen in his debae Harvard Law School proessorLucian Bebchuk argues agains insulaion and or urher shareholder involve-

men in public corporaions Bebchuk and ohers have esed he effec o hedge

und acivism on he perormance o companies up o five years laer30 Tey ound

ha while he sock does experience a shor-erm gain a he ime o he acivism

hose gains do no come a he cos o long-erm perormance

Bebchukrsquos conclusion ha shor-erm rading increases long-erm value should

neverheless be greeed wih some skepicism I is imporan o disinguish

beween he direc effecs o hedge und acivism on he individual firms argeed

by hedge unds and heir poenial effecs on he marke as a whole I could be

ha he specific firms argeed by acivis hedge unds perorm no worse han

nonarges bu his is because all managers eel pressure o mee analyssrsquo quar-

erly earnings projecions or ear o being argeed Tis would mean ha acivis

hedge unds encourage shor-ermis behavior ha desroys value in a way ha he

economeric mehods employed by Bebchuk and his co-auhors canno deec

Institutional investors and long-term focus

No every rend however has pushed markes oward shor-ermism One o he

mos imporan rends in public markes is he rise o insiuional invesors such as

pension unds and nonprofi endowmens Unlike many small-ime invesors hese

are sophisicaed shareholders wih he resources o inves in analysis and he ime

horizon o say paien wih he companies whose shares hey own Evidence sug-

gess ha hey have provided a bulwark agains increasing shor-ermism




A sudy by hree leading economiss991252Philippe Aghion o Harvard Universiy

John Van Reenen o he London School o Economics and Luigi Zingales o he

Universiy o Chicago991252shows a posiive relaionship beween insiuional own-

ership and a commonly used measure o innovaion ciaion-weighed paens

Tey find an even sronger relaionship beween insiuional ownership and he

efficiency o RampD spending991252ciaion-weighed paens per dollar o RampD spend-ing31 Anoher sudy finds ha managers are more likely o reduce RampD spending

in response o an earnings decline when insiuional ownership is low32

Aghion Van Reenen and Zingales argue ha here is more innovaion under

insiuional ownership because innovaion is risky991252he payoff comes years away

i a all991252and managers may avoid i since hey can be held responsible or even

a single bad quarer o earnings33 Insiuional invesors make i saer or manag-

ers o inves in innovaion because heir incenives push hem oward paience

Relaedly insiuional invesors do no need o rely on exernal analyss who

appear o cause firms o innovae less34

Tis is no o say ha insiuional invesors are a panacea A longer ime horizon

does no mean ha insiuional invesors can ignore shor-erm benchmarks

especially when modern risk-managemen pracices require even ar-sighed inves-

ors o adjus heir posiions in response o shor-erm share price flucuaions

One poenial danger posed by insiuional invesors is ha hey can seek own-

ership o muliple firms ha compee in he same indusry encouraging hem

o raise prices For example a recen sudy showed ha in he airline indusry

concenraion resuling rom common ownership may be 10 imes higher han he

level a which he US Deparmen o Jusice believes firms can raise prices35 As

a resul ldquoicke prices are approximaely 3ndash5 percen higher on he average US

airline roue han would be he case under separae ownershiprdquo Less compeiion

no only means higher consumer prices oday bu also less innovaion36




Short-termism as a market failure

I is no he role o he governmen o preven individual firms and inves-

ors rom making bad decisions In heory markes provide he discipline o

reward firms ha maximize long-run profis which in urn produces he mos

efficiency and mos economic growh Bu markes are no always perec and

hose imperecions991252known as marke ailures991252can provide an incenive or

firms and invesors o make he wrong decision or hemselves and sociey An

imporan role o governmen is o creae condiions ha ensure markes have

he inormaion and incenives o provide ha discipline

Perhaps he marke ailure mos relevan or shor-ermism is he asymmeric

inormaion beween managers and invesors Managers have ar more inor-

maion abou he firmrsquos uure perormance han invesors do which may pro-

vide hem wih an incenive o mislead invesors abou he firmrsquos perormance

Depending on oher acors markes can eiher discourage or reinorce hese

incenives producing very differen economy-wide oucomes

Harvard economis Jeremy Sein developed a model showing how he asymmery

o inormaion reduces long-erm invesmen and growh37 Te value o a sock is

deermined by he expecaion o uure earnings and curren earnings serve as a

signal o uure earnings991252i earnings are high oday all else equal invesors can

expec earnings o be high omorrow In Seinrsquos model managers reallocae money

rom uure invesmens ino curren earnings as a way o rick markes ino believ-

ing he firm is more profiable han i really is

Te problem is ha his behavior does no ool he marke i some managers udge

heir earnings he marke hen expecs all managers o udge heir earnings and

inerpres repored earnings wih a big grain o sal Now boh invesors and man-agers are suck in wha Sein calls a ldquoprisonerrsquos dilemmardquo Managers mus reallocae

invesmens ino curren profis because invesors may no longer believe i when




managers say hey are invesing in he long erm and invesors will assume profis

are ar worse han hey really are Boh markes and managers would be beter off i

he managers did no behave myopically and markes did no expec hem o bu

he incenives or managers o deec and boos curren earnings are oo grea

Nobel Prize-winning economis George Akerlo showed how inormaion asym-meries such as hose described above can hrow a marke ino a deah spiral38

For example someone selling cars knows which car is an unreliable lemon while

he car buyer does no buyer skepicism hen drives down prices o he poin ha

he only cars lef on he marke really are lemons Relaedly he Bank o Englandrsquos

Haldane argues ha shor-ermism in finance hreaens is own ldquoGreshamrsquos lawrdquo

in which impaien money could drive ou paien money39 He poins o wo di-

eren possible oucomes991252one in which ldquopaience wins he dayrdquo ldquohose pursu-

ing long-erm sraegies flourishrdquo and ldquohe racion o long-erm invesors risesrdquo

Under he oher ldquoprices deviae persisenly rom undamenalsrdquo and ldquohe specu-

laive balance o invesors rises increasing he degree o misalignmen in pricesrdquo

Te danger o he sock marke becoming Akerlorsquos lemon car marke is ha

firms wih ample growh opporuniies could disappear rom public markes

alogeher because o he pressure o orgo long-erm invesmen opporuniies

Invesors would push he remaining public firms o ocus urher on shor-erm

earnings raher han long-erm value as belie spreads ha firms ha sell heir

shares publicly have limied growh opporuniies Tis would make i harder

or already squeezed middle-class amilies o save or college or reiremen

since mos o hem only have access o public equiy markes which growing

firms would abandon Tis could exacerbae he dynamic idenified by Tomas

Pikety in which wealhy households earn a higher rae o reurn on heir inves-

mens han middle-class households40

Noably hese dynamics canno be solved by compleely aligning he incenives

beween invesors and managers Tere is also a lack o credibiliy ha makes

long-erm invesmens muually unatracive o shareholders and he execuives

managing heir firms I is he role o public policy o atemp o ameliorae he

inormaion asymmeries ha reward shor-ermism and nudge markes oward

he oucome in which raional paien money wins Imporanly asymmericinormaion beween managers and invesors canno be eliminaed enirely bu

he role o public policy is o promoe beter-srucured markes ha reduce he

role o asymmeric inormaion and lead o beter economy-wide oucomes




An obvious example is laws agains insider rading Economis Ross Levine o

Haas Business School a he Universiy o Caliornia Berkeley along wih Lai

Wei and Chen Lin o Te Universiy o Hong Kong recenly documened he

benefis o markes and he economy rom insider-rading enorcemen41 Using

inernaional daa on insider-rading convicions he auhors find ha ldquoenorcing

insider rading laws spurs innovaion991252as measured by paen inensiy scopeimpac generaliy and originaliyrdquo42 Te auhors also find companies issue more

equiy as insider-rading enorcemen rises suggesing ha beter enorcemen

leads o beter uncioning markes Invesors innovaors and economies all win

when he role o asymmeric inormaion in equiies markes alls




Policy recommendations

While his repor ocuses on explaining he evidence or shor-ermism and is

causes below are a ew policy proposals ha he Cener or American Progress

believes would push markes oward a beter equilibrium in which long-erm

invesors and he US economy as a whole win

Nudging managers

Execuive compensaion clearly has a srong effec on he behavior o execuives

hemselves Congress should weak he provision making perormance compensa-

ion more han $1 million ax deducible in ways ha moivae CEOs o ocus on

he long erm such as requiring ha opions ake longer o ves

Insider rading erodes public confidence in markes reduces incenives or

managers in innovaive indusries o make long-erm invesmens makes i more

difficul or young firms o raise he capial hey need rom he public and reduces

economy-wide innovaion Greaer effors o boh enorce exising laws and

publicize enorcemen acions would require no acion rom Congress reduce he

influence o asymmeric inormaion and improve he incenives or managers o

make producive invesmens

One o he reasons or he explosion o share buybacks is a regulaory change991252

adjusmens o rule 10b-18 o he Securiies Exchange Ac in 1982 gave firms a

sae harbor proecion rom insider-rading charges when firms purchase sock on

he open marke43 Te US Securiies and Exchange Commission or SEC should

repeal his rule as i gives managers an opaque way o manipulae sock prices

Firms would sill be able o make ender offers o buy back shares a a cerain price by a cerain dae which is much less suscepible o manipulaion




Te SEC should require more requen and comprehensive reporing on share

buybacks including ransaced prices relaive o share prices a differen ime hori-

zons Since here is currenly no deailed longer-erm reporing on how buybacks

occur i is difficul or invesors o ell when firms are buying shares in a way ha

ransers money rom shareholders o managemen Buyback daes should also be

more easily compared o execuive opion exercise daes Bringing more ranspar-ency o his process would make buybacks a beter deal or shareholders and less

subjec o insider manipulaion

Nudging investors

Te ax code currenly rewards invesmens by giving invesors a preerred rae

on capial gains when invesors hold he asse or a leas one year Te purpose

o his ax code provision is o reward long-erm invesors bu one year is no

nearly long enough A sliding capial gains ax991252a ax rae ha alls he longerhe asse is held991252would provide greaer rewards o long-erm invesmen rela-

ive o shor-erm speculaion

Large CEO pay slices991252he share o compensaion among he op five execuives

paid o he CEO991252are associaed wih worse perormance and lucky opion grans

or he CEO44 Since he slice may reflec he economic rens991252or excess compen-

saion991252ha he CEO is exracing rom he firm he SEC should consider requir-

ing is prominen disclosure as well as benchmarking o similar firms o reduce

monioring coss or invesors

Given ha execuivesrsquo incenives push hem so srongly oward ocusing on he

shor erm companies should ake affirmaive seps o empower longer-erm

invesors One measure would be o give long-erm shareholders proxy access

which would pu independen long-erm ocused nominees on equal ooing

o fill a vacancy on a companyrsquos board o direcors Anoher proposal is o adop

minimum holding periods and ime-based vesing o shareholder voing righs45




Conclusion

Tere is clear evidence ha firms are excessively ocused on boosing curren

earnings and have sacrificed long-erm invesmen o do so Te incenives ha

managers ace clearly play an imporan role in generaing his oucome Te effec

o hedge unds pursuing shor-erm rading sraegies is more ambiguous while

insiuional invesors do appear o nudge firms o ocus on he long erm

Imporanly here is a clear raionale or public policy o encourage managemen

and invesors o ocus on he long erm by improving access o inormaion andnudging heir incenives oward he long erm A longer-erm ocus means more

invesmen which in urn means more jobs higher wages and greaer innovaion




About the authors

Marc Jarsulic is he Vice Presiden or Economic Policy a he Cener or

American Progress He has worked on economic policy maters as depuy saff

direcor and chie economis a he Join Economic Commitee as chie econo-

mis a he Senae Banking Commitee and as chie economis a Beter MarkesHe has praciced ani-rus and securiies law a he Federal rade Commission

he Securiies and Exchange Commission and in privae pracice Beore coming

o Washingon he was proessor o economics a he Universiy o Nore Dame

He earned an economics PhD a he Universiy o Pennsylvania and a JD a he

Universiy o Michigan His mos recen book is Anatomy of a Financial Crisis

Brendan V Duke is a Policy Analys or he Cenerrsquos Middle-Ou Economics proj-

ec His research ocuses on inequaliy and economic growh Duke compleed

his maserrsquos in economics and public policy a Princeon Universiyrsquos Woodrow

Wilson School o Public and Inernaional Affairs in 2014 His sudies ocusedon labor economics social insurance macroeconomics and economerics He

also holds a bachelorrsquos in poliical science rom Macaleser College in S Paul

Minnesoa

Michael Madowitz is an Economis a he Cener or American Progress whose

work has ocused on labor markes financial markes ax policy household

budgeing in differen phases o lie and a variey o environmenal economics

opics In addiion o his work in suppor o he Economic Policy eam Madowiz

conducs research or peer-reviewed publicaions in he fields o environmenal

economics public finance and macroeconomics




Endnotes

1 US Census Bureau ldquoIncome Poverty and Health Insur-ance Coverage in the United States 2014rdquo Press releaseSeptember 16 2015 available at httpswwwcensusgovnewsroompress-releases2015cb15-157html

2 US Bureau of Labor Statistics ldquo(Seas) Employment-

Population Ratio - 25ndash54 yrsrdquo available at httpdatablsgovtimeseriesLNS12300060 (last accessedOctober 2015)

3 Federal Reserve Economic Database ldquoReal MedianHousehold Income in the United Statesrdquo available athttpsresearchstlouisfedorgfred2seriesMEHOINU-SA672N (last accessed October 2015)

4 Jason Furman ldquoBusiness Investment in the UnitedStates Facts Explanations Puzzles and Policiesrdquo Pro-gressive Policy Institute September 30 2015 availableat httpswwwwhitehousegovsitesdefaultfilespagefiles20150930_business_investment_in_the_united_statespdf

5 Josh Bivens and Lawrence Mishel ldquoUnderstanding theHistoric Divergence Between Productivity and a TypicalWorkerrsquos Payrdquo (Washington Economic Policy Institute

2015) available at httpww wepiorgpublicationunderstanding-the-historic-divergence-between-productivity-and-a-typical-workers-pay-why-it-matters-and-why-its-real

6 Examples include Curtis S Dubay ldquoHow Tax ReformWould Help American Familiesrdquo (Washington TheHeritage Foundation 2014) available at wwwheritageorgresearchreports201410how-tax-reform-would-help-american-families Alex Brill ldquoA pro-growthprogressive and practical proposal to cut business taxratesrdquo (Washington The American Enterprise Institute2012) available at https wwwaeiorgpublicationa-pro-growth-progressive-and-practical-proposal-to-cut-business-tax-rates

7 William G Gale and Peter R Orszag ldquoEconomic Effectsof Making the 2001 and 2003 Tax Cuts PermanentrdquoInternational Tax and Public Finance 12 (2) (2005) 193ndash

232 Austan Goolsbee and Mihir A Desai ldquoInvestmentOverhang and Tax Policyrdquo Brookings Papers of Economic Activity (2) (2004) available at httpwwwbrookingseduaboutprojectsbpeapapers2004investment-overhang-tax-policy-desai Danny Yagan ldquoCapital TaxReform and the Real Economy The Effects of the 2003Dividend Tax Cutrdquo Working Paper 21003 (NationalBureau of Economic Research 2015) available at httpwwwnberorgpapersw21003 Jane G Gravelle andDonald J M arples ldquoTax Rates and Economic Growthrdquo(Washington Congressional Research Service 2014)available at httpswwwfasorgsgpcrsmiscR42111pdf Thomas L Hunger ford ldquoTaxes and the EconomyAn Economic Analysis of the Top Tax Rates Since 1945(Updated)rdquo (Washington Congressional ResearchService 2012) available at httpswwwfasorgsgpcrsmiscR42729pdf William G Gale and Andrew ASamwick ldquoEffects of Income Tax Changes on EconomicGrowthrdquo (Washington The Brookings In stitution 2014)

available at httpwwwbrookingsedu~mediaresearchfilespapers20140909-effects-income-tax-changes-economic-growth-gale-samwick09_effects_income_tax_changes_economic_growth_gale_sam-wickpdf

8 Lawrence H Summers and Ed Balls ldquoReport of theCommission on Inclusive Prosperityrdquo (WashingtonCenter for American Progress 2015) available athttpswwwamericanprogressorgissueseconomyreport20150115104266report-of-the-commission-on-inclusive-prosperity

9 Ibid

10 Katie Hamm and Carmel Martin ldquoA New Vision forChild Care in the United Statesrdquo (Washington Centerfor American Progress 2015) available at httpswwwamericanprogressorgissuesearly-childhoodreport20150902119944a-new-vision-for-child-care-in-the-united-states-3

11 The yield on corporate debt for example has experi-enced a secular decline since the early 1980s See Fed-eral Reserve Economic Database ldquoMoodyrsquos SeasonedAaa Corporate Bond Yieldrdquo available at httpsresearchstlouisfedorgfred2seriesWAAA(last accessed Octo-ber 2015)

12 Larry Fink ldquoBlackRock CEO Larry Fink tells the worldrsquosbiggest business leaders to stop worrying about short-

term resultsrdquo Business Insider April 14 2015 availableat httpwwwbusinessinsidercomlarry-fink-letter-to-ceos-2015-4

13 George A Akerlof ldquoThe Market for lsquoLemonsrsquo QualityUncertainty and the Market Mechanismrdquo The Quarterly Journal of Economics 84 (3) (1970) 488ndash500

14 John R Graham Campbell R Harvey and Shiva Rajgo-pal ldquoThe economic implications of corporate financialreportingrdquo Journal of Accounting and Economics (40)(2005) 3ndash73

15 Dominic Barton and Mark Wiseman ldquoFocusing capitalon the long termrdquo McKinsey Insights December 2013available at httpwwwmckinseycominsightslead-ing_in_the_21st_centuryfocusing_capital_on_the_long_term

16 This report defines ldquoshort-termismrdquo as the failure offirms to make profitable investmentsmdashinvestmentswith a positive net present valuemdashbecause theyexcessively discount future benefits This follows closelyto the concept used by Haldane and means that short-termist behavior by definition reduces a firmrsquos valuebecause the firm is not maximizing profits

17 Andrew G Haldane ldquoWho owns a companyrdquo Uni-versity of Edinburgh Corporate Finance ConferenceMay 22 2015 available at wwwbankofenglandcoukpublicationsDocumentsspeeches2015speech833pdf

18 Ibid

19 Ibid

20 William Lazonick ldquoStock buybacks From retain-and

reinvest to downsize-and-distributerdquo (Washing-ton The Brookings Institution 2015) available athttpwwwbrookingsedu~mediaresearchfilespapers20150417-stock-buybacks-lazonicklazonickpdf




21 Richard Davies and others ldquoMeasuring the costs ofshort-termismrdquo Journal of Financial Stability (12) (2014)16ndash25

22 John Asker Joan Farre-Mensa and AlexanderLjungqvist ldquoCorporate Investment and Stock MarketListing A Puzzlerdquo Review of Financial Studies 28 (2)(2015) 342ndash390

23 Davies and others ldquoMeasuring the costs of short-termismrdquo

24 Michael Jensen and William Meckling ldquoTheory of thefirm managerial behavior agency costs and ownershipstructurerdquo Journal of Financial Economics (3) (1976)305ndash360

25 Alex Edmans and others ldquoStrategic News Releases inEquity Vesting Monthsrdquo Working Paper 20476 (NationalBureau of Economic Research 2014) available athttppapersssrncomsol3paperscfmabstract_id=2489152

26 Jeffrey R Brown Nellie Liang and Scott WeisbennerldquoExecutive Financial Incentives and Payout Policy FirmResponses to th e 2003 Dividend Tax Cutrdquo The Journal ofFinance 62 (4) (2007) 1935ndash1965

27 Ilia D Dichev and others ldquoEarnings quality Evidencefrom the fieldrdquo Journal of Accounting and Economics 56(2ndash3) (2013) 1ndash33

28 Stephen J Terry ldquoThe macro impact of short-termismrdquoVoxEU January 17 2015 available at httpwwwvoxeuorgarticlemacro-impact-short-termism

29 Leo E Strine ldquoCan We Do Better By Ordinary InvestorsA Pragmatic Reaction to The Dueling IdeologicalMythologists of Corporate Lawrdquo The Columbia LawReview 114 (449) (2014) 449ndash502 Martin Lipton andWilliam Savitt ldquoThe Many Myths of Lucian Bebchukrdquo The Virginia Law Review 93 (3) (2007) 733ndash758

30 Lucian A Bebchuk Alon Brav and Wei Jiang ldquoThe Long- Term Effects of Hedge Fund Activismrdquo The ColumbiaLaw Review 115 (5) (2015) 1086ndash1156

31 Philippe Aghion John Van Reenen and Luigi ZingalesldquoInnovation and Institutional Ownershiprdquo AmericanEconomic Review 103 (1) (2013) 277ndash304

32 Brian Bushee ldquoThe Influence of Institutional Investorson Myopic RampD Investment Behaviorrdquo The AccountingReview 73 (3) (1998) 305ndash333

33 Aghion Van Reenen and Zingales ldquoInnovation andInstitutional Ownershiprdquo

34 Jie (Jack) He and Xuan Tian ldquoThe dark side of analystcoverage The case of innovationrdquo Journal of FinancialEconomics 109 (3) (2013) 856ndash878

35 Joseacute Azar Martin C Schmalz and Isabel Tecu ldquoAnti-Competitive Effects of Common Ownershiprdquo WorkingPaper 1235 (University of Michigan Ross School ofBusiness 2015)

36 Philippe Aghion and others ldquoCompetition And Innova-tion An Inverted-U Relationshiprdquo Quarterly Journal ofEconomics 120 (2) (2005) 701ndash728 Richard BlundellRachel Griffith and John Van Reenen ldquoMarket ShareMarket Value and Innovation in a Panel of British Manu-facturing Firmsrdquo Review of Economic Studies 66 (1999)529ndash554

37 Jeremy C Stein ldquoEfficient Capital Markets InefficientFirms A Model of Myopic Corporate Behaviorrdquo TheQuarterly Journal of Economics 104 (4) (1989) 655ndash669

38 Akerlof ldquoThe Market for lsquoLemonsrsquordquo

39 Andrew Haldane ldquoPatience and Financerdquo Oxford ChinaBusiness Forum September 9 2010 available at wwwbisorgreviewr100909epdf

40 Thomas Piketty Capital in the Twenty-First Century

(Cambridge MA Belknap Press 2014) pp 430ndash431

41 Ross Levine Chen Lin and Lai Wei ldquoInsider Trading andInnovationrdquo Working Paper 21634 (National Bureau ofEconomic Research) available at httppapersnberorgtmp88478-w21634pdf

42 Ibid

43 Lazonick ldquoStock buybacksrdquo

44 Lucian A Bebchuk KJ Martijn Cremers and Urs CPeyer ldquoThe CEO Pay Slicerdquo Journal of Financial Econom-ics 102 (1) (2011) 199ndash221

45 The Aspen Institute ldquoOvercoming Short-termism A Callfor a More Responsible Approach to I nvestment andBusiness Managementrdquo (2009) available at httpwwwaspeninstituteorgsitesdefaultfilescontentdocs

pubsovercome_short_state0909_0pdf



Our Mission

The Center for American

Progress is an independent

nonpartisan policy institute

that is dedicated to improving

the lives of all Americans

through bold progressive

ideas as well as strongleadership and concerted

action Our aim is not just to

change the conversation but

to change the country

Our Values

As progressives we believe

America should be a land of

boundless opportunity where

people can climb the ladder

of economic mobility We

believe we owe it to future

generations to protect theplanet and promote peace

and shared global prosperity

And we believe an effective

government can earn the

trust of the American people

champion the common

good over narrow self-interest

and harness the strength ofour diversity

Our Approach

We develop new policy ideas

challenge the media to cover

the issues that truly matter

and shape the national debat

With policy teams in major

issue areas American Progres

can think creatively at thecross-section of traditional

boundaries to develop ideas

for policymakers that lead to

real change By employing an

extensive communications

and outreach effort that we

adapt to a rapidly changing

media landscape we move

our ideas aggressively in thenational policy debate



Long-Termism or LemonsThe Role of Public Policy in

Promoting Long-Term Investments









16 Conclusion

18 Endnotes

Contents











ha expansion3





FIGURE 1


Log index 1960 = 0

-002

-001

000

001

002

003

004

005

006

007

008



1960 1970 1980 1990 2000 2010 2015




















new capial goods6







FIGURE 2







-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2015


After-tax profits



















































in public markets
























































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach























16 Conclusion

18 Endnotes

Contents











ha expansion3





FIGURE 1


Log index 1960 = 0

-002

-001

000

001

002

003

004

005

006

007

008



1960 1970 1980 1990 2000 2010 2015




















new capial goods6







FIGURE 2







-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2015


After-tax profits



















































in public markets
























































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach


























ha expansion3





FIGURE 1


Log index 1960 = 0

-002

-001

000

001

002

003

004

005

006

007

008



1960 1970 1980 1990 2000 2010 2015




















new capial goods6







FIGURE 2







-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2015


After-tax profits



















































in public markets
























































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach
































new capial goods6







FIGURE 2







-2

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010 2015


After-tax profits



















































in public markets
























































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach


































































in public markets
























































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach
















































































selling heir shares



















long-erm perormance























































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach






































































































































































Nudging managers




























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach


























Nudging investors





















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach



















Conclusion












About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach



















About the authors














Minnesoa










Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach



















Endnotes













9 Ibid










18 Ibid

19 Ibid




























42 Ibid







Our Mission











Our Values












champion the common



Our Approach









































42 Ibid







Our Mission











Our Values












champion the common



Our Approach


















Our Mission











Our Values












champion the common



Our Approach














