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Politics and Short Termism

August 3, 2015

What is an asset that pays $1 immediately worth? $1 obviously. If it cost less than that, people would buy it and make money, and if it cost more, no one would buy it.

What is an asset worth $1 a year from now worth? Well, that depends on a lot of things: Time preference, alternative investments, risk of default, etc. But fundamentally, the value of the asset is based on the payout in the future, and the relative value of future money compared to money today.

For some reason, when it comes to stocks, many people’s heads turn to mush. If you know amount of all dividends and stock buybacks, so you can calculate the present value of the stock precisely. Dividend payments from this year get added to dividend payments one year in the future, plus payments two years in the future, all the way up until the company goes bankrupt. The value of any stock is the amount that people expect the company to pay out in the future, discounted by the amount of time until those payments happen, the risk that a company will go bankrupt, and a risk that their profit will go down. Adding a resale market doesn’t change things because the new buyers can also calculate present values.

The thing that is bad about short termism is not the short term profitability, it’s the long term losses. But if everyone knows the long term profits are going down, the asset price will adjust accordingly. If the stock’s price goes down as a result on short termism, CEOs will be punished for their poor performance and there is no systemic problem.

So what do you need for short termism to actually be a problem? There need to be people who are tricked by it to sell to. Investor A knows the company’s profitability will decrease because of short termism, but Investor B does not, so Investor A sells the stock to Investor B at a high price. This is a game of cat and mouse and in the real world, sometimes companies pull off the deception, and sometimes they do not. Companies which do short term strategies a lot go out of business and are replaced by other companies, so short termism is unsurprisingly, a short term only strategy.

Enter the politicians. Capitalism bashing is popular, especially when you attack something that sounds evil and no one understands. Bonus points if your solution has literally nothing to do with the problem. In this case, the proposed solution is to give CEOs more independence from boards of trustees. Of course several CEOs have jumped on board in support as well. But boards are comprised of primarily long term investors. You don’t get a seat on the board if you are running a month long short operation, you get a seat if you’ve held stock for a fair amount of time or hold a large fraction of the stock. These are precisely the sorts of people who DON’T want short termism. Even if you did get a majority stake in a company, if you do a bunch of short termist stuff, who exactly are you going to sell your shares to? Private equity firms were accused of this sort of behavior, but when investigated, it turned out not to be true. If you have a reputation for short termism, you must take extra care not to do it so that you can convince people to buy the stock from you eventually. Doing short termist policies is not a long term strategy! In any event, giving CEOs more independence will likely result in more short termist polices, not less.

Kevin Erdmann:
“Isn’t it funny how so many people hold these two opinions in their heads at the same time:
1) Wall Street is just focused on the next quarter and they push corporations to have short term motives.
2) There was a stock market bubble 15 years ago built around bidding up prices to unprecedented levels for an entire basket of firms which had never been profitable and had no near-term plans for being profitable.”

One Comment leave one →
  1. August 4, 2015 10:42 am

    People are paranoid and are all to quick to believe that others are manipulating things against their interest (this is especially true if they see them as others like foreigners, rich people, another nationality, religion or race.) Resisting that kind of thinking (without being naive) is the key to being a good investor same for being a good economist.

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