Corporate Short-Termism in the Fiscal Cliff’s Shadow

CAMBRIDGE – Economic trends are sometimes more closely related to one another than news reports make them seem. For example, one regularly encounters reports of governments’ financial troubles, like the “fiscal cliff” in the United States and the debt crisis in Europe. And much attention has been devoted, often in nearby opinion pieces, to the view that hyperactive equities markets, particularly in the US and the United Kingdom, push large corporations to focus disproportionately on short-term financial results at the expense of long-term investments in their countries’ economies.

The two are not unconnected. And examining that connection provides a good opportunity to assess the weaknesses and ambiguities of the longstanding argument that furiously high-volume stock-market trading shortens corporate time horizons.

The conventional thinking is that as traders buy and sell corporate stocks more often, they induce corporate managers to plan for shorter and shorter horizons. If institutional investors refuse to hold stocks for more than a few months, the thinking goes, CEOs’ time horizons for corporate planning must shrink to roughly the same timeframe.

Policymakers in Europe and the US are urged to act on this conventional thinking: Something must be done to insulate CEOs, boards, and managers from the financial markets’ ever-shortening time horizons. The UK’s official Kay Review from last July and the European Union’s Green Paper on corporate governance, adopted by the European Parliament earlier this year, diagnose corporate short-termism as a serious problem and point policymakers toward solutions. American commentators – and, increasingly, US judges – want to insulate CEOs and boards further from their firms’ trading shareholders.