Ways to Circumvent Short-Termism
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Short-termism is defined as an investor’s extreme concentration on profits made on the basis of short-term analysis at the cost of long-term benefits. This short-sightedness of investors forces them to make decisions based on the quarterly and annual performance of stocks and companies. Short-termism also arises due to the boost in the number of available investment opportunities. A constant update on the performance of the stock market further aggravates this situation. In an attempt to move ahead of the market, investors tend to engage in several short-term transactions. In addition to this, a decline in stock value during the short-term creates the fear of losing hard-earned money, resulting in immediate corrective actions by investors, leading to short-termism.
Issues created by Short-Termism
Short-termism leads to several issues, not only for the investor but for companies as well.
1. High transaction costs
This is one of the major drawbacks of short-termism. Investors react to every movement of the stock market resulting in an excessive number of transactions. This results in higher taxes, increased transaction costs and fees, and lower average returns. Still, investors somehow fall prey to the myth that a greater number of transactions can lead to better results and more control over the equity portfolio. An asset allocator is considered backwards when the instantaneous transaction is not done with a change in asset value.
2. Long-term profits foregone
With a reduction in the holding time of stocks, investors lose out on the long-term profits that can be earned from those stocks. Not every stock is meant to perform in the short run. Market forces cause fluctuation in the stock values. Those who maintain calm during these fluctuations are likely to earn returns in the long run. Those who react with a slight change can never know if the stock was meant to perform positively or not. Historical data suggests that the share market has witnessed a striking reduction in the average holding time of stocks. Currently, an investor holds a stock for an average of a couple of months, whereas in 1940, this period was approximately seven years.
3. Hindrance in advancements
Due to short-termism, companies are under pressure to display positive performance even during monthly and quarterly reports. In its absence, the company tends to lose investors. This prevents companies from investing in staff, research and development, product innovation, etc. These strategies require substantial investment, and initially, there are no visible returns. The positive outcomes from these approaches commence only after a couple of years. Nowadays, investors do not give that much time to companies for giving out profits.
4. Societal penetration of myopia
The myopic philosophy of shareholders has now become an intrinsic part of our society and public life. It has been followed so consistently that it has crossed the boundaries of corporations and financial markets. Short-termism has adversely affected institutions in every industry. Long-term investments are being alleviated due to schemes that promote current consumption. Nearsightedness has become a way of life, stretching beyond the dimensions of investment.
While short-termism has become the new investment approach, several drawbacks make it important to circumvent it. The following points can be used to achieve this goal.
1. Frequency of financial statement issuance
This is the most widely sought-after solution for short-termism. It has been long suggested that companies should eliminate the issuance of quarterly and half-yearly financial statements. This will prevent investors from taking hastened decisions based on the financial parameters of the company.
2. Extension of compensation measurement period
It has also been suggested that the period over which the compensation for executives is decided should be extended. This will allow employees to focus on the quality of transactions, rather than the number of transactions. Currently, the remuneration is paid depending upon the short-term achievements. However, the incentives should be given through the period when the profits from the transactions are realized, thereby justifying the incentives.
3. Modification in performance parameters
This change is extremely important. The indicators along which the company’s performance is measured must be modified. The performance indicators should include the company’s growth drivers, rather than the stock value.
4. Focus on sustainability
Financial managers must promote the concept of sustainability rather than only profitability in the short-term. The idea of long-term investment should be reinforced among investors. However, this can only be achieved if financial managers themselves are not judged against only financial performance.
5. Strategic thinking by the board of directors
Board of directors can have a solution to the problem of short-termism. They can think in a strategic manner leading to an amalgamation of short-term accomplishments with long-term objectives. To achieve this purpose, directors must be well versed with the company’s policies. They must be aware of the comprehensive plans of the organization and the sector in which it is operating. This strategic approach can be instrumental in allowing directors to be well prepared for dealing with circumstances that result in short-termism. These circumstances can include share buybacks, modifications to dividend policies, etc.
To sum it up
Short-termism has affected not only companies but also investors and society like an epidemic. While it might seem tough to circumvent this myopia, it is not unattainable. However, it will require efforts from investors, directors, financial intermediaries, and executives to achieve this goal. The solutions to this problem do exist but can be quite complicated in terms of understanding and execution. Therefore, it is only suitable to take the assistance of a knowledgeable and experienced financial advisor to formulate and implement the solutions.