Short-termism in business: causes, mechanisms and consequences

Short-termism in business:

causes, mechanisms

and consequences

EY Poland Report

Abbreviations and denitions

SPIQ Standard & Poor’s Capital IQ

GICS GlobalIndustryClassicationStandard

LTIP Long-TermIncentivePlan

Table of Contents

Executive Summary 1

1 What is short-termism? 5

2 The causes of short-termism among public companies 11

2.1 Factors contributing to the short-termist behaviour of investors 13

2.2 The instruments of investor pressure on the executives 17

3. The consequences of short-termism 21

3.1 The channels of the impact of short-termism on a company’s

performance 23

3.1.1 Shortened CEO tenure 23

3.1.2 Neglectofinvestmentactivity 24

3.1.3 Neglectofhumancapital 25

3.2 EY empirical analysis 27

3.2.1 Thecompanies’performancevariables(explainedvariables) 28

3.2.2 Theimpactvariables(explanatoryvariables) 29

3.2.3 Statisticalanalysis 35

3.2.4 Summaryoftheeconometricresults 38

3.2.5 Summaryoftheempiricalanalysis 43

4. Conclusions 45

Short-termism in business: causes, mechanisms, consequences

ExecutiveSummary

Executive Summary

►Therightbalancebetweenashort-andlong-termperspectiveis

crucialforthesustainabilityofasuccessfulbusiness.However,there

isalotofevidence,notleasttherecentnancialcrisis,toshow

thatlong-termobjectiveshaveoftenbeenneglectedbecauseoftoo

muchconcentrationonshort-termgoals.Thisistheshort-termism

phenomenon,whichdeterioratesrms’competitiveness,increases

systemicrisk,andreducesthelong-termpotentialoftheentire

economy.ThisEYPolandReportcontributestothediscussiononshort-

termismthroughempiricalresearchconductedforthe1024largest

companieslistedontheEuropeanstockmarkets.

Short-termistbehaviourisparticularlyvisibleinthecaseofpublic

companies,whichareoftenunderpressurefromtheirshareholders

todelivershort-termoutcomes.Amongthefactorsthatcontributed

tothispressureare:newtechnologies,reducedtradingtimesand

transactioncosts,increasedmarketvolatility,mediacoverage,andthe

increasingroleofinstitutionalinvestors.

Shareholdershaveinstrumentstoeffectivelyexecutetheirexpectations

ofshort-termoutcomes.Theseinstrumentsincludeshapingthe

remunerationschemesoftheexecutivesbasedontheirshort-term

performance,aswellastheabilitytoremoveexecutivesfromofce

iftheydonotmeetinvestorexpectations.Short-termismisoften

reinforcedbycompanies’marketcommunicationandnancialreporting

practices,whichlargelyfocusontheshort-termperformanceand,from

theshareholders’pointofview,serveasaninstrumentformonitoring

theirshort-termgoals.Consequently,short-termismoftenresultsin

“earningsmanagement”ratherthanbuildingthelong-termvalueofthe

company.

Therearedifferentchannelsthroughwhichshort-termismmayadversely

affectcompaniesandtheeconomyasawhole.Theseare:shortened

CEOtenure,theneglectofinvestmentactivityandtheneglectofhuman

capital.EY’sempiricalanalysisfocusesontheformertwo.

Inlightofasignicantshorteningoftheexecutives’contractsand

performanceevaluationintervals,weshowthataddressingtheissue

ofmanagementstabilityshouldbeofgreatimportance.Theresults

ofourresearchindicatethatanincreasedCEOtenurepositively

inuencesthecompany’sprotabilityandmarketcapitalisation.In

particular,anadditionalyearofCEOtenureleads,inthelong-run,toan

averageincreaseinthecompany’sannualprotability(ROE)by0.3p.p.

Interestingly,wedonotndanyrelationbetweenthetime-orientation

Short-termism in business: causes, mechanisms, consequences

ExecutiveSummary

ofculturesandtheaveragetenureofexecutives.Thisfurther

strengthenstheviewthat,asfaraslistedcompaniesareconcerned,

short-termismhasbecomeaglobal,culture-widephenomenon.

Areductionininvestmentexpendituresisanotherimportantchannel

oftheimpactofshort-termismonacompany’sperformance.Capital

outlaysareoftenmadewiththeaimofimprovingtherm’slong-term

competitivenessandcapacity.EY’sanalysisshowsthatariseincapital

expenditurestototalassetsratioby10p.p.inthelong-termleads

toanincreaseintheaverageROEby4.5p.p.,whileariseincapital

expenditurestototalrevenueratioby10p.p.leads,inthelong-run

(here15years),toanaverageincreaseinthegrowthofthecompany’s

marketcapitalisationby7.1p.p.However,intheshort-term,

investmentoutlaysmayleadtoadeteriorationinreportednancial

indicators,whichinturnmayresultinadeclineinthecompany’s

shareprice.Weconrmthatbyshowingthatincreasingthecapital

expenditurestototalrevenueratioby10p.p.leadstoashort-term

decreaseinthecompany’smarketcapitalisationgrowthby1.6-3.9p.p.

Therefore,whileexecutivesrecognisetheproblemofexcessiveshort-

termism,theymaybereluctanttoallocatecapitaltoachievelong-

termgoalsastheywanttoavoidmissingtheshort-termconsensus

estimateandthusdisappointingthecompany’sshareholders.Available

surveyresultsconrmthatexecutiveswoulddelayorsacriceprojects

creatinglong-termvalueinordernottomissshort-termearnings

targets.

Withrespecttothat,animportantndingoftheEY’sresearchisthat

thelongertheCEOtenure,thehigher(onaverage)arethecompany’s

investmentoutlays.Inparticular,anadditionalyearofCEOtenure

leads,onaverage,toanincreaseintherm’scapitalexpenditureto

totalrevenuesratioby0.2p.p.

Ourestimationresultsalsopointtoapositiveimpactofappointingan

insidersuccessoronthecompany’sprotability,bothintheshort-and

long-term.ItmayreectanadditionaldimensionoftheCEO’svaluable

experienceasthatofthecompany’sinsider.However,wedonotnd

thiseffectonthecompany’slong-termmarketvalue.Neitherhave

weidentiedanyimpactofanoutsideroraninsidersuccessoronthe

company’sinvestmentactivity.

Inaddition,theobtainedresultsindicatethatincreasingtheroleof

Long-TermIncentivePlans(LTIP)intheCEOremunerationscheme

positivelyinuencesthecompany’sROEintheshort-term.Thateffect,

however,hasnotbeenidentiedforthemarketcapitalisationor

Short-termism in business: causes, mechanisms, consequences

ExecutiveSummary

investmentactivityofthecompany(long-termeffectsoftheLTIPhave

notbeenanalysed).

ShortCEOtenureandneglectofinvestmentoutlaysdecreasea

company’slong-termvalueandprotability,aswellastheabilityto

adapttonewmarketconditionsandcompeteonaglobalscale.Inthis

way,ifshort-termismaffectsmanyrms,ittranslatesintothereduced

potentialoftheentireeconomy.Consequently,tacklingtheproblemof

theshortenedexecutives’contractsmaybeonewayofaddressingthe

issue of short-termism.

Reducingtheproblemofshort-termismrequirestheinvolvementofall

stakeholders.Inparticular,executivesexcessivelyfocusontheshort-

termperformanceinresponsetomarketexpectationsandpressure

frominvestors.Engagementwiththeinvestorcommunityshould

thereforebeanimportantpartofthestrategytocountertheproblem

of short-termism.

Onewayofimprovingcommunicationwithstakeholdersmaybe

relatedtochangesinthereportingframework,inparticularamending

thestructureofinformationtowardsmorelong-term,fundamental

guidance.Thismayhelpinshiftingthefocusofinvestorstowards

thelong-termvalueandtruedriversofbusinesssuccess,aswellas

attractingnew,long-terminvestors.

Anothermeasurewouldbetoincentiviseexecutivestopaymore

attentiontolong-termvaluecreation.Thismaybeachievedthrough

structuringtheremunerationschemesofexecutivessothata

signicantportionoftheircompensationisbasedonthelong-term

performanceofthecompany.

Yetanothersolutionrecommendedintheliteratureistoprovidetax

andregulatoryincentivesforlong-durationholdingsofsecuritiesand

disincentivesforshort-durationholdings.

Takingintoaccountthecoststhatshort-termismentails,notonly

forpubliccompanies,butalsoforthewholeeconomy,westrongly

recommendconsideringawiderangeofmeasuresthatmayhelp

toaddresstheexcessivefocusonshort-termgoals.Ifdealtwith

effectively,itwouldimprovethecapacityandcompetitiveness

ofnationalbusinesses,encouragelong-termvaluecreationand

contributetothewelfareofsociety.

Section 01

What is

short-termism?

‘Anybodycanmanageshort.Anybodycan

managelong.Balancingthosetwothings

iswhatmanagementis’

JackWelch,GeneralElectricCEO

Short-termism in business: causes, mechanisms, consequences

What is

short-termism?

Theactionsthatwetakeinoureverydaylife

haveconsequences.Theseconsequences,

however,mayvaryovertime.Whereassome

ofourdecisionsresultinimmediateoutcomes,

forothersittakestime,evenyears,tosee

theeffects.Decision-makingbecomesmore

complexifactionsleadingtolong-term

benetsrequireshort-termsacrices,orif

achievingshort-termgoalscomesatthecost

oflong-termobjectives.

Forinstance,wehavetomakeachoice

betweencurrentconsumption,whichgives

ussomebenetsstraightaway,andsavings,

whichareusuallyconnectedwithsome

increased,butdelayed,gains.Therefore,ifwe

wanttoberewardedwithahighercash-ow,

andthusconsumptioninthefuture,wehave

tosacricepartofourtoday’sconsumption,

which–bydenition–isnotsomethingthat

wearehappyabout.Anotherexampleof

suchdecision-makingproblemiswhether

tocontinuethefull-timeeducationorstart

aprofessionalcareerrightaway.Extended

full-timeeducationisusuallyrelatedboth

withadirectcost(tuitionfee)andalternative

costs(onecouldstartajobearlierandearn

wagesinsteadofstudying).Moreover,itoften

requiresalotofefforttopassallthecourses,

soitentailspersonalcostsaswell.However,

inthelongerrun,additionalyearsspentin

educationareusuallyconnectedwithabetter

salary,highersocialstatusand/orprestige.

Therefore,thedecisionwhethertostudy(and

howmuch)ornot,isactuallyaninvestment

decisionthattakestimeandeffortbeforeit

pays off.

Similardilemmasarefacedbybusinesses.

Whensomeonestartsanewrm,thecosts

andsacricescomerst–onlyaftertime,

sometimesmanyyears,willthewhole

investmentreachthebreak-evenpoint.

Andsometimesitneverdoes.Thetrade-offs

betweenlong-termandshort-termbenets

reiteratethroughoutthewholelifecycleofthe

company.Forinstance,thermcandistribute

itsprotsintheformofdividends,resultingin

short-termrewardstotheowners(individual

orinstitutionalshareholders),oritcanuse

thesefundstonanceinvestmentsinnew

productivecapacitiesortechnologies.Infact,

hardlyanycompaniesusealloftheirsurplus

casheitherfordividendsorforinvestment.

Ontheonehand,ifweneglectinvestment

activitythentherm,evenifinitially

successful,willgraduallyloseitscompetitive

advantage.Ontheotherhand,ifwefocus

toomuchonthelong-rungoals,thecompany

mightfailtoproducetheoutcomesnecessary

tosurviveuntilthelong-termbenets

materialise.Inparticular,thermmaylose

liquidityifinvestorsorbanksdonotaccept

suchapolicyandcutoffexternalnancing.

Orinvestorsmaysimplylosetheirpatience

andremovetheCEOfromofce.Theright

balancebetweenashort-andlong-term

perspectiveiscrucialforthesustainabilityof

asuccessfulbusiness.JackWelch,theauthor

oftheopeningquote,understoodthatperhaps

betterthananyoneelseduringhis20yearsin

ofceasaCEOofGeneralElectric.Duringhis

term,themarketcapitalisationofthecompany

increasedbymorethan2800%.

 GE(2014),Past Leaders, John F. Welch, Jr., Chairman

& CEO 1981 – 2001,http://www.ge.com/about-us/

leadership/proles/john-f-welch-jr

Short-termism in business: causes, mechanisms, consequences

Whatisshort-termism?

However,recentexperience,notleastthe

nancialcrisis,hasshownthatinsteadof

ensuringabalance,long-termobjectives

haveoftenbeenneglectedbecauseoftoo

muchconcentrationonshort-termgoals

(seeFrame1).Thisresultsinthephenomenon

of short-termism,whichwedeneasthe

excessive focus of decision-makers on

short-term goals at the expense of longer-

term objectives. Short-termism results

in insufcient attention being paid to the

strategy, fundamentals and the long-term

value creation of a rm or an institution.

Itmustbestressedthatcaringaboutshort-

termgoalsshouldnotbeconsideredaproblem

per se,theproblemofshort-termismoccurs

whendecision-makerssacrice long-term

goals,orevenneglecttoformulatethem,and

insteadexcessivelyconcentrateonshort-term

benets.

Alegitimatequestioniswhetherweshould

careabouttheshort-termismissue?Onemight

saythatitistheproblemofcertaincompanies

andweshouldletthemarketdoitsjob.

However,thereareatleastseveralarguments

whyweshouldcare.Firstofall,short-

termismmayapplynotonlytocompanies,

butalsotootherinstitutions,includingpublic

regulators. If short-termism dominates the

policyofthelatter,itsconsequencesmight

affectallthemarketparticipants.If,for

example,governmentpolicyisdeterminedby

ashort-termperspective,itmayhaveadverse

macroeconomicandsocialconsequences,

includinganimpactoneconomicgrowth,

theunemploymentrateorpricedynamics.

Inparticular,thegovernmentmaybetempted

toincreasepublicexpendituresbefore

electionswiththeaimofwinningmorevotes.

Suchashort-termorientedpolicy,however,

mightresultinlong-termcosts,becausean

increaseinpublicdebtduetotheinitialscal

expansionwouldhavetobecompensatedfor

bythesubsequentscaltightening,leadingto

aneconomicslowdownandincreasedvolatility

ofthebusinesscycle.Thiswouldclearlyaffect

allthehouseholdsandcompaniesinthe

economy.

Secondly,anexcessivefocusonshort-term

goals may result in a similar and simultaneous

behaviourofmanyotherrmsandinstitutions.

Inparticular,thisbehaviourmaytaketheform

ofexcessiverisktakingtomaximizeshort-term

earnings.Forexample,nancialinstitutions

mayinvestinassetswithhiddenriskortakeon

excessivedebtjusttoincreasetheirshort-term

prots.

Insuchasetting,short-termismmay

lead to systemic risk,affectingthestabilityof

theentireeconomicsystem.Thishasbecome

evidentespeciallyinthecaseoflargenancial

institutionsissuingsubprimemortgages,which

allowedthemtomakefastbutunsustainable

prots.Itledtothehousingbubble,theburst

ofwhichresultedintheglobaleconomiccrisis

(seeFrame1).Therefore,short-termismmay

leadtomacroeconomicimbalancesfollowedby

asuddeneconomicdownturn.

Finally,totheextentthatshort-termismleads

totheneglectofinvestmentactivity,itreduces

rms’internationalcompetitivenessandtheir

capabilitytorespondeffectivelytonewmarket

challenges.Short-termismthusresultsinthe

reducedpotentialofindividualcompanies,but

alsoofthewholeeconomy.

Basedontheabove,thereislittledoubtthat

alleviatingtheproblemofshort-termism

wouldcontributetobuildingabetterworking

world.Ontheonehand,thereisanincreasing

amountofliteratureonthemechanisms

underlying the problem of short-termism

2 LynneL.Dallas(2012),Short-Termism, the Financial

Crisis, and Corporate Governance,LegalStudies

ResearchPaperSeries,ResearchPaperNo.12-078.

Short-termism in business: causes, mechanisms, consequences

Whatisshort-termism?

anditsdestructiveimpactoncompanies.

Manyreportsandarticlesconrmthatthe

decisionsofCEOsbringingfastgainsbothto

shareholdersandtoexecutives,oftenentail

long-termcoststothecompany.Ontheother

hand,thereislittleempiricalresearchonthis

matter,otherthanthatbasedonsurveys.This

EYPolandreportaimstoreducethatgap.

Thegoalofthisreportistocontributetothe

discussiononshort-termismthroughempirical

researchconductedforEuropeancompanies,

which–toourknowledge–havenotbeenthe

subjectofmanystudiessofar.

Thereportisstructuredasfollows.Section2

describesthecausesofshort-termisminthe

contextofincentivesfacedbythedecision-

makersinacompany.InSection3wediscuss

theconsequencesofshort-termism,with

aparticularfocusonlistedcompanies.This

partofthereportdrawsontheavailable

literature,aswellasonEY’sempirical

ndingsforEuropeancompanies.Detailsof

ourmethodologicalapproach,includingthe

technicaldescriptionofdataandeconometric

models,areincludedintheAppendix.

 TheAppendixtothisreportisavailableontheEY

website:www.ey.com/PL/short-termism

Short-termism in business: causes, mechanisms, consequences

Frame 1

Short-termism and the nancial crisis.

Chart 1. The role of short-termism in the recent nancial crash

on the US real estate market

Financial

innovations,

sales of “bad”

loans

Crisis

Focuson

shortterm goals

Large

ﬁnancial

institutions

Exotic

ﬁnancial

instruments

Toxic assets

Development

and burst

of the ﬁnancial

asset bubble

Source: EY.

Short-termismphenomenonplayedakey

roleinthechainofeventsthatledtothe

economicmeltdownbeginningin2007.Before

thenancialcrisisoutburst,largenancial

institutionswereinterestedinsellingasmany

loansaspossible,creatingan“originate-to-

distribute”model.Theideawastochargefees

forgivingcredit,andthentouseextremely

complicatednancialinstrumentsinorder

todispersetheriskthroughoutthenancial

markets.Thismadeitpossibleforbanksto

grantmortgageseventocreditorsunableto

repaythem(NINJAloans–“noincome,nojob

andnoassets”),astheconsequenceswere

disguisedbythecomplexityofthenancial

innovations.Moreover,thoseresponsiblefor

grantingloanswerenotsomuchinterested

inthequalityasinthequantityofnew

mortgages,forwhichtheywererewardedwith

bonuses.

Inthisway,anincreasingnumberof

consumerscouldaffordahousenanced

throughamortgage,whichledtoskyrocketing

housingprices.Inreactiontothisballooning

demand,thenancialmarketsstartedto

actasifrealestatepriceswouldriseforever,

looseningthecreditworthinesscriteriaeven

further.Andstill,underthethen-binding

supervisionstandards,ever-risinghousing

pricesmadenancialinstitutions’balance

sheetslookmoreandmorehealthy,reinforcing

theabovecycle.

Finally,manynancialinstitutionsreached

amomentatwhichtheconsequencesof

short-termismbecameevident–therealestate

bubblewasabouttoburst.Itbecameclear

thatthesituationinthehousingmarketwas

unsustainable and that “subprime mortgages”

wouldlikelyinictseriousdamageonthe

wholeUSnancialsector.Exoticnancial

instruments,sofartreatedasanattractive

innovationmakinghousingloansarelatively

safesourceofprot,suddenlybecame

recognisedasextremelyriskyandovervalued

assets.Thisleftbankswithahugeamount

of“toxicassets”,raisingtheurgentneedto

repairtheirbalancesheets,whichrequired

asignicanttighteningofcreditcriteria.

Thisinturnadverselyaffectednon-nancial

companiesastheacross-the-boardcredit

crunchleftmanyofthemunabletonance

theiractivity.Asaresult,theeconomicslump

becamemoreandmoresevereandwas

spreadingaroundtheworld.

* ThediscussioninthisframeisbasedpartlyonDallas,op.cit.andAmiyatoshPurnanandam(2010),

Originate-to-Distribute Model and the Subprime Mortgage Crisis,AFA2010AtlantaMeetingsPaper.

Whatisshort-termism?

Section 02

The causes

of short-termism

among public

companies

Short-termism in business: causes, mechanisms, consequences 01 August 2014

main headerKey ndings

Short-termism in business: causes, mechanisms, consequences

The causes

of short-termism

among public

companies

• Publiccompaniesareoftenunderpressureofinvestorswhoexpect

short-termoutcomes

• Factorscontributingtotheshort-termistbehaviourofinvestors

include:newtechnologies,globalisationofnancialmarkets,

reducedtradingtimesandtransactioncosts,marketvolatility,

constantmediascrutinyofmarketconditionswithanemphasis

ontheshort-termperformanceindicators,andtheincreasingrole

ofinstitutionalinvestors

• Shareholdersmayexecutetheirpressureonthecompany

byshorteningthetenureofexecutivesorinuencingtheir

remunerationschemes

• Publiccompanies’communicationandreportingpracticesoften

amplifytheshort-termismproblem.Issuingearningsguidance

andfrequentnancialreportingobligationsmakeexecutives

excessivelyfocusonmeetingthemarketshort-termexpectations,

notwithstandingthelong-termvalueofthecompany

Therearemanysourcesofshort-termism

inthebehaviourofrms,butinthecase

ofpubliccompaniesonefactordeserves

particularattention.Thisisthemarket

pressureexertedbyshareholdersonthe

executives,andinparticularontheCEO

ofacompanytodelivernancialresultsin

a short time span. It is a major reason for the

shiftinfocusofrmsandtheirmanagement

towardsshort-termgoalsatthecostoflong-

term strategy.

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

Amongthefactorsthatcontributedtothe

short-termistbehaviourofshareholdersare

newtechnologies,reducedtradingtimes

andtransactioncosts,marketvolatility,

mediacoverage,andtheincreasingroleof

institutionalinvestors–alladdingtoshort-term

performancepressure.Therearenowfewer

barriers to short-termism.

Inrecentdecades,globalisationand

technologicalprogresshaveledtoasubstantial

reductionintransactioncosts,makingit

mucheasierforinvestorsbothtoallocateand

reallocatetheirfunds.Forinstance,nowadays

peopledonothavetocallorvisitabrokerto

buysecurities–theycanmaketransactions

viatheInternetatanytimeandwithlittle

ornocommissionfee.Thismakesitpossible

forinvestorstoeasilymovetheircapitalfrom

onecompanytoanother,oreventoswitch

tocompletelydifferentmarkets,suchasthe

corporatedebtmarket,thesovereigndebt

marketorthederivativesmarket.Theycan

alsoeasilymovetheircapitalbetweenthe

marketsofdifferentcountries.Havingsomany

investmentopportunitiesmakesitmucheasier

forinvestorstoallocatetheirfundsaccording

totheirownriskproleandpreferences

towardsreturns.

Inaddition,therapiddevelopmentofnew

technologieshasresultedinspreadingnew

informationaroundtheworldwithinminutes,

anytime,dayornight,makingitpossiblefor

investorstorespondalmostimmediatelyto

changesinthemarketsituation.Thishas

creatednewpossibilitiesforinvestorsto

pursueshort-termprotsandhas

strengthenedthetendencyinthemodern

societyofexpectingimmediatereturns.

Moreover,constantmediascrutinyofmarket

conditionswithanemphasisputonshort-

termperformanceindicatorsmayexacerbate

investors’concentrationonthecurrent

situation,whileneglectingabroaderpicture

ofcompanies’condition.

Suchanabundanceofhigh-frequency

informationtranslatesintoalikelyinformation

overloadandmakesithardforindividual

investorstoprocessallthedatainatimely

manner. Their natural response is often to pass

thefundstoaspecialisedinvestmententity

withtheabilitytoprocessandusethemassive

amountsofinformationinordertondthe

bestinvestmentopportunities–toinstitutional

investor(seeChart2).Thisisalegalentity

thatcancarryouttransactionsusingfunds

frommanyvarioussources–individualsor

otherinstitutionalinvestors.Examplesinclude

banks,pensionfunds,investmentfunds,hedge

fundsandprivateequityfunds,whoserole

hassubstantiallyincreasedinequitymarkets

overthelasthalfacentury.Forinstance,inthe

mid-1960s,institutionalinvestorsheldaround

16%ofallpubliclylistedstocksintheUSA,

and46%intheUnitedKingdom,whereasin

the2010sthesenumbershaveincreasedto

around60%and89%,respectively.

 LouisePocock(2013),Curbing Excessive Short-

Termism. A Guide for Boards of Public Companies,

ThoughtLeadershipPaper,AustralianInstituteof

CompanyDirectors,http://www.companydirectors.

com.au/Director-Resource-Centre/Publications/Book-

Store/Short-termism-thought-leadership-paper

 Çelik,S.andM.Isaksson(2013), Institutional Investors

as Owners: Who Are They and What Do They Do?,

OECDCorporateGovernanceWorkingPapers,No.

11,OECDPublishing,http://www.oecd.org/naec/

Institutional%20investors%20as%20owners.pdf

2.1

Factors contributing to the

short-termist behaviour of investors

Short-termism in business: causes, mechanisms, consequences

Institutionalinvestorsareassessedwithregard

totheoverallreturnfromtheirportfolios,and

comparedwiththeresultsachievedbytheir

competitors.Moreover,thetechnological

changeshaveallowedclientsofinstitutional

investorstotracktheirperformanceon

acontinuousbasis,whichhasreinforcedtheir

focusonshort-termreturns.Insuchasetting,

thelonger-termperspectiveisoftenlost,as

clientsofinvestmentfundsareunwillingto

waitthatlongandcanshifttheirmoneyfrom

oneinvestmentfundtoanotherwithasingle

click(usuallyatanegligibletransactioncost).

Asaresult,institutionalinvestorsmayfeel

anincentivetofocusonshort-termresultsin

ordertoretaintheirclients.

In the pursuit of the required short-term return

onthemanagedassets,institutionalinvestors

usuallycarryoutfrequentadjustmentsoftheir

portfoliostructure,withoutmuchattention

being paid to the fundamentals of the

individualcompanies.This,inturn,resultsin

disregarding the long-term strategy

andfundamentalvalueofthermsowned

byaparticularinstitutionalinvestor.What

gainsimportanceistheperformanceof

agivencompanyintheshortrun.Ifitisnot

satisfactory,sharesheldinthatcompany

mightbereplacedwithothersecuritieswithin

seconds.Thistendencyhasbeenreinforced

bythefactthatfundmanagersareusually

assessed on the basis of their short-term

performance.Theymaybegradedandredon

thebasisofshort-termoutcomesevenwhen

thepurposeoftheinvestmentistoprovide

forretirementbenetsinmanyyears.

suchasetting,eveniffundmanagersbelieve

thatacompanyisapromisinglong-term

investment,theymaynotpurchaseitsstocks

justbecauseofwhatthepricemightdointhe

short-term.

Shorteningofnancialinstitutions’investment

horizonhasbeenreectedintheaverage

holdingperiodforstocksinprofessionally

managed funds that has dropped from about

sevenyearsinthe1960stolessthanone

 DavidGonski(2012),A Competitive Country Picks

Winners,TheAustralianFinancialReview

 Pocock,op.cit.

Thecausesofshort-termismamongpubliccompanies

Chart 2. Sources of pressure exerted on managers by investors.

PRESSURE EXERTED ON MANAGERS BY INVESTORS

Focus on the short-run and quick earnings

New technologies

24/7 media

coverage

Rapid ﬂows of

information

Globalisation

Growth of ﬁnancial

markets and

international capital

ﬂows, reduced transaction

costs

Increase in market

volatility

More developed ﬁnancial

intermediation services

More investment

opportunities and

potential for short-term

returns

Changes in the shareholding

structure: the growing role of

institutional investors with

a short term investment horizon

Source: EY.

year today.

Althoughindividualinvestors’

horizonhasalsobeenshortened,itislonger

thanthatofinstitutionalinvestors.

910

Given

anincreasedroleofinstitutionalinvestorsin

nancialmarkets,thismayindicatethatthere

isanincreasingpressureonthemanagement

ofcompaniestodelivershort-termresultsin

ordertoavoidthesaleoftheirsharesand

 AlfredRappaport(2006),Ten Ways to Create

Shareholder Value,SeptemberHarvardBusiness

Review:OnPoint1,2-3<http://analystreports.som.

yale.edu/internal/S2008/tenways.pdf>.

 LimeiChe,(2011),Investors’ performance and

trading behaviour on the Norwegian stock market,

AdissertationsubmittedtoBINorwegianBusiness

SchoolforthedegreeofPh.D.,SeriesofDissertations

5/2011,BINorwegianBusinessSchool.

 OECD(2011),The Role of Institutional Investors in

Promoting Good Corporate Governance,Corporate

Governance,OECDPublishing.

thedeclineoftheircompany’smarket

capitalisation.Indeed,thereisaliterature

providingevidencethatshort-termtrading

bytransientinstitutionalinvestorsleads

to “earnings management” and that

short-termismispervasiveinthebusiness

community,causinglong-termdamagetoboth

nancialandnonnancialrms.

 See,forexample,Dallas,op.cit.

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

Chart 3. S&P 500 daily price return index over the last 40 years, close

value, and the 100 days moving standard deviation [index points]

400

800

2000

200

Jan 74 Jan 79 Jan 84 Jan 89 Jan 94 Jan 99 Jan 04 Jan 09 Jan 14

100 days moving standard deviation [left axis] S&P Index [right axis]

Source: EY calculations based on Reuters EcoWin data.

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

Thedevelopmentoftheglobalnancial

markets,togetherwiththeincreasingroleof

institutionalinvestors,hasbeenaccompanied

notonlybyasurgeinthevolumeoftradein

shares,butalsobystrongeructuationsin

shareprices(seeChart3).Increasednancial

marketvolatilitymakesitmoredifcultfor

theindividualinvestorstoanalysethedata.

Thisstrengthenstheirpropensitytooutsource

themanagementoftheirfundstonancial

intermediaries–institutionalinvestors.

Moreover,whenmarketsarevolatile,itismore

difcultforinvestorstoassessthelong-term

potentialofacompany,whichincreasestheir

focusonshort-termindicatorsandfurther

discouragelong-terminvestors.Financial

marketsvolatilitythusampliestheproblem

of short-termism.

Thefactthatshort-termismispervasive

andentrenchedincompanies’management

hasbeenconrmedbyempiricalstudies

investigatingthediscountfactorthat

boardmembersapplytofuturecashows.

Thediscountfactoristherateatwhich

economicagentsreducethevalueofdelayed

cash-owsrelativetotheimmediatepayoffs.

Therefore,ifthediscountfactorishigh,the

valueassignedbytheeconomicagenttothe

futurebenetsislow,relativetothepresent

benets.Highdiscountfactorsthuspointto

ashort-termismproblem,whichwedeneas

excessivefocusonshort-termgoals.

Inthisregard,itisworthquotingtheresults

ofthesurveyconductedamongCEOsfromall

Fortune1000rmsin1995,whichshowed

thattheaveragediscountrateapplied

tofuturecashowswasequalto12.2%,

“distinctly higher than equity holders’ average

rates of return and much higher than the

return on debt during the last half-century.”

Inamorerecentstudyfrom2011,Andrew

HaldaneandRichardDaviesfoundthat,

amongUKandUSlistedrms,“cash-ows

5 years ahead are discounted at rates more

appropriate 8 or more years hence; 10 year

ahead cash-ows are valued as if 16 or more

years ahead; and cash-ows more than

30 years ahead are scarcely valued at all.”

Bothstudiesthusprovideevidencethatpublic

companiesaresufferingfromtheproblem

of short-termism.

 JamesM.PoterbaandLawrenceH.Summers(1995),

A CEO Survey of U.S. Companies’ Time Horizons and

Hurdle Rates,SloanManagementReview,http://

sloanreview.mit.edu/article/a-ceo-survey-of-us-

companies-time-horizons-and-hurdle-rates/

 AndrewHaldaneandRichardDavies(2011),

The Short Long,Speechdeliveredatthe29thSociété

UniversitaireEuropéenedeRecherchesFinancières

Colloquium,Brussels,www.bis.org/review/r110511e.

pdf

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

2.2

The instruments of investor

pressure on the executives

Investorsthatareinterestedintheshort-

termreturnsoftenexertpressureonthe

company’smanagementtodeliverfastresults.

However,onemightwonderwhyexecutives

shouldsubmittothispressure,ratherthan

simplysticktothepolicyconsistingofthe

balancedlong-,medium-andshort-term

goals.Theanswermaylieintheinstruments

thatshareholdershaveinordertoeffectively

executetheirexpectationsofshort-term

outcomes.Wediscusssomeofthese

instrumentsbelow.

Thereareavarietyofcorporategovernance

stylesandeachcountryhasitsown

institutional setting regarding the delegation

andexecutionofpowerwithinpublic

companies.Inspiteofthesedifferences,

thereisacommonfactorintheformof

asupervisoryboardoraboardofdirectors

appointed by the shareholders to represent

theirinterests(werefertosuchbodiesas

to the board).

Theboardhasthepowerto

appointanddismisstheCEO,aswellasto

establishtheremunerationscheme(orto

delegate these responsibilities to other bodies

accountabletotheboard).

 InGermanyandothercontinentalEuropeancountries,

the supervisory board and the executive board are

separate and usually the former appoints the latter. In

theUSandtheotherAnglo-Saxoncountries,thesetwo

bodiesactasasingleboard of directors.

Remunerationschemesareoneofthe

standardtoolsofinuencingtheCEO’s

behaviour.Mostofusareinterestedin

maximisingourpayandsoaretheexecutives.

Therefore,ifexecutives’bonusesdependon

achievingsomeshort-termgoals,suchas

anincreaseinthemarketcapitalisationor

annualrevenuegrowth,theyhaveincentives

topaymoreattentiontotheseperformance

indicatorsatthecostoflonger-termvalue

creation.

Inaddition,executivesmayown

stockoptionswithshortvestingperiods,

whichmightstimulateactionstoboostthe

short-termperformancebecauseitwould

allowexecutivestobenetfromsellingtheir

holdingsbeforethelong-termcostsoftheir

decisionsmaterialise.Suchremuneration

schemesarethereforelikelytocausetheCEO

tofocusheavilyonthecompany’sshort-term

results.

 MalcolmS,Salter(2012),How Short-Termism Invites

Corruption... And What to Do About It,WorkingPaper

No12-094,HarvardBusinessSchool.

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

Chart 4. The reactions of CEOs to the pressure on short-term prots

exerted by investors

Manage

rs reach

mainly

short-term

objecti

vesset by

vestors, often

inc

onsistent with the

long-t

erm interests

of the

company

Pressure exerted by Investors

Remuneration schemes

rewarding short-term

performance

Growing importance of

short-term

communication with the

capital market

Increased

probabilityof

dismissal

Short-termism

Maximising

remuneration

Avoiding the

"disappointment” of the

market in the short term

Employment

concerns

The boardShare price

Source: EY.

Theriskofbeingremovedfromofce

isanotherfactorinuencingtheCEO’s

behaviour.Afailuretoachieveshort-term

goals might disappoint shareholders and result

inthenegativeassessmentoftheexecutives.

ThismayevenleadtothedismissaloftheCEO

beforetheendofhisterm,orthedecision

not to reappoint him for another term.

Insomecountries,itisevenamatterofthe

institutionalsettingwithinthelistedcompany

thattheCEOhastobereelectedannually

(asthisisthecaseinmanyofthelargestlisted

companiesintheUK).

Insuchasetting,the

positionofCEOismorevulnerablethaninthe

past,meaningthatexecutiveshavestrong

incentivestosatisfytheshort-termneedsof

the shareholders in order to safeguard their

positions.

 Pocock,op.cit.

Yetanotherfactorreinforcingtheshort-

termistbehaviouroftheexecutivesisthe

marketcommunicationandnancialreporting

practices,whichlargelyfocusontheshort-

termperformance.Indeed,insomecountries

itisobligatoryforthelistedcompaniestoissue

quarterlynancialstatementsinadditionto

their annual reports. From the shareholders’

pointofview,itimprovesthetransparency

ofthelistedrms,butatthesametimeit

servesasaninstrumentformonitoringtheir

short-termgoals.Moreover,shareholder

pressurehasmademanyexecutivesintroduce

furtherchangesintheircommunicationpolicy.

Inparticular,manycompaniesissue“earnings

guidance”,whichistheofcialprediction

formulatedbythecompanyregardingits

Short-termism in business: causes, mechanisms, consequences

Thecausesofshort-termismamongpubliccompanies

futureprots.

Analystsoftenusethis

guidanceasareferencepointfromwhichto

buildtheirforecast.Theproblemariseswhen

theperformanceofthecompanyisassessed

almostexclusivelyagainsttheconsensus

estimate,whilethebroaderpictureis

neglected.Inparticular,whereasacertainlevel

ofreturnonequityratioinsomecircumstances

mightbeperceivedasanextremelygood

result,ifitmisses(negatively)theconsensus

estimate,itisperceivedasafailureandmay

leadtothesaleofsharesinthecompany

(especiallybyinstitutionalinvestors)and

asubsequentdeclineintheshareprice.

Fromthepointofviewofthelong-termgoals

oftherm,thismightnotbeaproblem

asitcontinuestogrowinfundamental

terms.However,itmayadverselyaffectthe

assessmentofexecutives,justbecausethey

didnotmeettheinvestors’expectations.

Asaresult,manyexecutiveshavebecome

hostagesoftheircommunicationwiththe

marketandoftheconsensusestimates.

Thishasincreasedtheriskthattoomuch

effortismadeonmeetingorexceeding

short-termmarketexpectations,whichmay

comeatthecostofneglectinglonger-term

opportunitiesforthecompany’sdevelopment.

 AsWarrenBuffetwarnedinhis2000Chairman’s

Letter,“(…)itisbothdeceptiveanddangerousfor

CEOstopredictgrowthratesfortheircompanies.

Theyare,ofcourse,frequentlyeggedontodoso

bybothanalystsandtheirowninvestorrelations

departments.Theyshouldresist,however,because

toooftenthesepredictionsleadtotrouble.”,http://

www.berkshirehathaway.com/letters/2000pdf.pdf.

Citedin:CommissionontheRegulationofU.S.Capital

Marketsinthe21stCentury(2007),Report and

Recommendations,U.S.ChamberofCommerce.

Agoodillustrationofthistrade-offcanbe

seenintheresultsofthesurveyconductedin

2004

bytheUSNationalBureauofEconomic

Research,indicatingthat78%of401nancial

executivesstatedthattheywouldsacrice

economicvaluetopreventearningstodepart

from the assumed path in the short term.

Theshort-termmarketcommunication

hasattractedsomuchattentiontowards

thefullmentoftheshort-termgoals

oftheshareholdersthat,in2007,the

U.S.DepartmentofCommercelaunched

areportwithrecommendationstostop

issuingtheearningsguidance,oratleast

lowertheirfrequencyandmakethemmore

comprehensive.

Italsorecommended

thatallthestakeholdersbeprovidedwith

additional information on the long-term

businessstrategy,whichmightbemuchmore

informativeofthecompany’sactualsituation

than merely short-term data.

 JohnR.Graham,CambellR.Harvey,ShivaRajgopal

(2004),The Economic Implications of Corporate

Financial Reporting,NBERWorkingPaper10550.

 CommissionontheRegulationofU.S.CapitalMarkets

in the 21

Century,opcit.

Section 03

The consequences

of short-termism

Short-termism in business: causes, mechanisms, consequences 01 August 2014

main header

Short-termism in business: causes, mechanisms, consequences

Key ndings

The consequences

of short-termism

• Themainchannelsforthenegativeimpactofshort-termismon

acompany’sperformanceincludeshorteningoftheCEO’stenure,

reducedinvestmentactivityofthermandneglectinghuman

capital

• Econometricanalysisshowsthatstabilityofmanagementpositively

inuencescompany’sprotabilityandmarketcapitalisation

• Anincreaseininvestmentexpenditureimprovescompany’slong-

termperformance.However,intheshort-termcapitaloutlayslead

toadeclineinthesharepriceofacompany,whichmaydiscourage

someexecutivesfromundertakingprotableinvestmentprojects

• TherearetwochannelsthroughwhichtheCEO’stenureinuences

theperformanceofacompany:(1)directpositiveimpactofthe

executive’sexperienceand(2)indirectimpactoftheCEO’stenure

throughapositiveeffectoninvestmentactivity,whichimprovesthe

long-termperformanceofacompany

• Consequently,theworldwidetendencyofshorteningtheCEO’s

tenurehastobeassessednegatively

Wealreadyknowthemechanismsthatlead

totheshort-termistbehaviourofcompany

executives,butwhatconsequencesdoes

excessivefocusonshort-termoutcomes

have–forthecompany,forinvestors,forthe

economy?Toanswerthisquestion,wemust

rstconductaliteraturereviewtoidentify

potentialchannelsthroughwhichshort-

termismmayaffectthesituationofrms.

Inthenextstepwerunanempiricalanalysis

focusingontheimpactofselectedchannelson

Europeancompanies.Wemeasurethisimpact

withrespecttoselectedperformancevariables

ofthecompany(marketcapitalisation,return

onequityratio).

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.1

The channels of the impact

of short-termism on a company’s

performance

Therearenumerouschannelsdiscussedinthe

literaturethroughwhichshort-termismmay

impactonacompany’sperformance.Among

them,threedeserveparticularattention:

1. Shortened CEO tenure

2. Neglectofinvestmentactivity

3. Neglectofhumancapital

3.1.1

Shortened CEO tenure

AsshowninSection2,shorteningoftheCEO’s

tenure is one of the instruments of pressure

exertedbyshareholdersonexecutives.This

mightnegativelyaffecttheperformance

ofacompanyforanumberofreasons.

Firstofall,experienceplaysamajorrolein

management–aCEOmightneedsometime

beforedevelopingabetterunderstanding

ofthefunctioningofthermanditsmain

potentialdrivers.This,inturn,maybecrucial

forformulatingandachievingacompany’s

long-termstrategy.Armfrequentlyreplacing

itsCEOmightbeevenunabletoformulate

suchastrategyatall.Andevenwhensuch

astrategyisformulated,itmaybechallenging

toachieveitunderunstablemanagement,

becausefrequentlyreplacedexecutivesmight

betemptedtodepartfromthepoliciespursued

bytheir(unsuccessful)predecessors.Inlight

ofthis,thendingsofKarlssonetal.(2008)

indicatingtheshorteningoftheaveragetenure

oftheCEOmaybeasourceofconcern.

Inparticular,theauthorsshowthatthemean

tenureofoutgoingCEOsamongthe2,500

toplistedcompaniesintheworlddropped

from8.8yearsin1995to7.2yearsin2007.

Moreover,Favaroetal.(2010)indicatethat

thistendencycontinued,withthemeantenure

decliningfurtherto6.3yearsin2009.

 Per-OlaKarlsson,GaryL.Neilson,JuanCarlosWebster

(2008),CEO Succession 2007: The Performance

Paradox,fromstrategy+businessissue51,Booz&Co.

 KenFavaro,Per-OlaKarlsson,GaryL.Neilson(2010),

CEO Succession 2000-2009: A Decade of Convergence

and Compression,strategy+businessissue59,

Booz&Co.

Atthesametime,asemphasisedbythe

authors,inthesecondhalfofthe20thcentury

itwastypicalforaCEOtoleaveacompany

aftera10-15-yeartenure.TheEuropeancase

isabitdifferentinthat,insteadofadecrease,

weobservedaslightincreaseintheaverage

tenureofoutgoingCEOsbetween1995and

2007.Ontheotherhand,however,inthat

periodtheaveragetenureofanoutgoing

EuropeanCEOwasverylowrelativetothe

worldaverage.Atthebeginningofthat

period,itwaslowerthan6years,andafter

onlyaslightimprovementupto2007,itstill

remainedbelowtheglobalaverage.

Duetoshorteningofexecutivescontracts

andperformanceevaluationintervals,CEOs

haveastrongincentivetopursueshort-

termobjectives,notwithstandinglong-term

consequencesoftheirdecisions.Executives

mayalsotendtofocusonoutcomesthatwill

materialiseduringtheirexpectedtenure,

andthusdisregardlonger-termeffectsthat

willoccuraftertheyhaveleftthecompany.

Moreover,insuchaninstitutionalsetting

executivesmaytakeonexcessiverisk,because

exceedingshort-termtargetsmayresultin

beingrewardedasignicantbonus,whereasin

thecaseofafailurethecostoflosingthejob

maynotbethathigh,aslongastheexpected

tenure is short.

Whilethischanneloftheimpactofshort-

termismoncompaniesisdiscussedinthe

literature,itisrarelyinvestigatedwiththeuse

ofadvancedquantitativemethods.Thisstudy

aimstollthatgap.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.1.2

Neglect of investment activity

Areductionininvestmentexpenditureis

anotherpotentiallyimportantchannelof

theimpactofshort-termismonacompany’s

performance.Thisisbecausecapitaloutlays

entailimmediatecostsandimpactonthe

company’scurrentnancialstatements,

whereasinvestment-relatedbenets

areusuallydelayedandoftenuncertain.

Investmentactivityalsoaffectsthecompany’s

dividendpolicy,foritreducesaportionof

earningsthatcouldotherwisebedistributed

toshareholders.Therefore,executiveswho

focusondeliveringshort-termresultsmay

haveincentivestoneglectinvestmentoutlays,

whichmightincreasetheexpecteddividend

andthusthepriceofcompanyshares.

Therefore,intheshortruntheneglect

ofinvestmentactivitymightleadtoan

improvementofthenancialsituationof

thecompany,whichmightberewardedby

themarkets.However,inthelongrun,this

couldleadtoadeteriorationofthecompany’s

competitivenessanditsabilitytoadaptto

rapidchangesinthemarket.

Short-termism,

throughneglectofinvestmentoutlays,may

thereforeleadtoaninefcientallocationof

fundsbypubliccompanies.

Theliteratureontherelationshipbetween

short-termistbehaviourandinvestment

activityismuchricherthaninthecaseof

shortenedCEOtenure.Forinstance,Mein

Cheng,K.R.SubramanyamandYuangZhang

(2007)

conductedastudyof1406USrms

andfoundthatrmsthatfrequentlyissued

quarterlyearningsguidance(whichturns

outtobestronglyrelatedtoexcessivefocus

onshort-termgoals)metorbeatmarket

consensusmorefrequently,butinvested

lessinR&Dandreportedalowerlong-term

earningsgrowthratethancompaniesthat

 LouisePocock,op.cit.

 MeiCheng,K.R.Subramanyam,YuangZhang(2007),

Earnings Guidance and Managerial Myopia, https://

www.kellogg.northwestern.edu/accounting/papers/

k.r%20subramanyam.pdf

issuedtheguidanceonlyoccasionally.The

literaturealsodiscussesthebehaviourof

executiveswhoareunderpressuretorapidly

improvethenancialresultsoftheircompany.

Accordingtothealreadycited2004survey,

inordertomeettheearningstarget,80%

ofrespondentswouldcutspendingonR&D,

advertisingandmaintenance,55%woulddelay

startinganewprojectand41%wouldturn

downapositiveNPVprojectaltogether.

Whilecompaniesrecognisetheproblemof

theexcessiveshort-termism,theymaybe

reluctanttoallocatecapitaltoaddresslong-

termissuesbecauseofmarketexpectations.

Themechanismoftheneglectofinvestment

activitywasalsoconrmedbythestudyof

SankjeevBhojraj,PaulHribar,MarcPicconiand

JohnMcInnis(2009),whoinvestigatedthe

performanceof1686rmsthathadmissed

theirearningspersharetargetbyonecent

(0.01ofaUSdollar)and2893companiesthat

hadbeatenthistargetbyonecentoverthe

period1988-2006.

Theauthorsshowthat

rmsthatmarginallybeatearningsforecasts

(‘byapenny’),butachievedthatforexample

throughthereductionofR&Dexpenditures,

facedshort-termstockpriceincreaserelative

tormsthatmarginallymissedtheearnings

forecasts,butdidnotresorttocuttingsuch

expenditures.Moreimportantly,thistendency

reversedovera3-yearperiod,showingthat

theconsequencesofsuchspendingdecisions

are different in the short and in the long-term.

Inotherwords,short-termgainsareoften

outweighedbylong-termcosts.

 Grahametal,op.cit.

 AlisonAtherton,JamesLewisandRoelPlant(2007),

Causes of Short-termism in the Finance Sector,

Discussion Paper (nal),InstituteforSustainable

Futures,UniversityofTechnologySydney.

 SanjeevBhojraj,PaulHribar,MarcPicconi,

JohnMcInnis(2009),Making Sense of Cents:

An Examination of Firms That Marginally Miss or Beat

Analyst Forecasts, TheJournalofFinance,vol.LXIV,

NO.5.

Short-termism in business: causes, mechanisms, consequences

Anotherimportantassetofacompanythat

maybeadverselyaffectedbytheshort-

termismphenomenonarethecompany’s

employees.Forexample,executiveswhowant

toimproveshort-termnancialstatements

mayhaveanincentivetosaveonthe

trainingoftheirstaff,ortorefrainfromthe

recruitmentprocess.Bothwouldreducecosts

incurredbythecompanyintheshort-term,but

itwouldbeachievedbyneglectinginvestment

inhumancapital.Suchconsequencesofthe

short-termistbehaviourareconrmedbythe

resultsofasurveyconductedin2012among

Britishentrepreneurs,managers,andtrade

union members.

Respondentstothesurvey

perceivedshort-termismasasignicant

ormajorimpedimenttothegrowthand

developmentoftheBritishbusiness.Suchan

opinionwassharedby92%ofthemembersof

theInstituteofDirectors(IoD,whichassociates

mainlysmallandmediumenterprises),86%

ofleadersoftradeunions,67%ofmembers

oftheIntellectorganisation(associatingIT,

communicationsandelectronicindustries),

and60%ofbusinessleaders.Amongthose

whoperceiveditasanimpediment,around

60%ofIoDmembers,45%ofIntellect

members,58%oftradeunionrepresentatives,

and30%ofbusinessleadersstatedthat,

amongotherthings,ittooktheformof

adisincentivetorecruit.

 GeorgeCox(2013),Overcoming Short-termism

within British Business. The key to sustained economic

growth, Anindependentreviewcommissionedbythe

Labour Party.

Neglectofhumancapitalcanalsotake

differentforms,includingexcessivereduction

inemployment.Layoffsareoftenbelievedto

begoodforacompanythatisintroubleas

ameanstorepairitsnancialsituationandas

anincentivetoboostproductivity.Thisiswhy

layoffsareusuallywelcomedbythenancial

marketsastheyareoftenassociatedwith

thecompany’sdeterminationtocarryout

painfulreformsandtoseeksavings.There

aremanysituationsinwhichthisistrue,but

sometimeslayoffsbecomeexcessiveand

harmful.Thisisparticularlythecaseduringan

economicslowdownwhenmanyexecutives,

drivenbyshort-termincentives,takeall

measuresavailabletoavoiddisappointingthe

company’sshareholders.Insuchasituation,

cuttingemploymentisoneofthequickest

waystoreducecostsandimprovethegures

presentedinthenancialstatement.Indeed,

announcingasignicantlayoffisoneofthe

surestwaystoincreasestockpricesinthe

short term.

 RonAshkenas(2012),Thinking Long-Term in a Short-

Term Economy, HarvardBusinessReview,http://blogs.

hbr.org/2012/08/thinking-long-term-in-a-short/.

Theconsequencesofshort-termism

3.1.3

Neglect of human capital

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

Chart 5. Layoffs as a measure to improve short-term results

Fall in share

prices as a result

of economic

slowdown

Companies cannot

effectively respond

to new challenges

and an increase

in demand

Layoffs

considered the

fastest solution

to increase share

prices in the

short term

Limited

availability

of skilled

workers

Short-term Long-term

Economic slowdownEconomic recovery

Source: EY.

Theshort-termbenetsofanexcessive

reductioninemploymentareoutweighed

bysubsequentcoststhatareincurredin

thelongerterm.Inparticular,cuttingthe

headcountdoesreducetheproduction

capacity(seeChart5),butthisisnotabig

issueduringaneconomicslowdown,whenthe

capacityutilisationislowandtheseemployees

maybeidleanyway.However,astheeconomic

situationimproves,thecompanymayquickly

reachitsbottlenecksandfurtherexpansion

wouldbelimitedduetotheinsufcient

availabilityofskilledworkers.Moreover,during

therecoveryitismuchhardertohireskilled

workersthattheshort-sightedexecutivesgot

ridofatthetimeofthetemporaryslowdown;

andndingnewemployeesandtrainingthem

istimeconsumingandcostly.Asaresult,

short-termismmayresultincompanies

sufferingfromcapacityconstraintsduring

theeconomicupturn,aswellastheirlimited

abilitytoseizenewgrowthopportunitiesand

effectivelyadapttonewmarketchallenges.

Consequently,short-termism,ifreected

inneglectingacompany’shumancapital,

deterioratestherm’scompetitivenessand

reducesitslong-termpotential.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.2

EY empirical analysis

Wehavealreadydiscussedvariouschannels

throughwhichshort-termismmayadversely

impactthelong-termperformanceof

companies.However,thisanalysishasbeen

mostlytheoreticalorbasedonthesurvey

results.Inthenextstepweaimtoconduct

aquantitativeempiricalanalysisthatfocuses

ontheimpactofshort-termismonthe

performanceofcompanies.Forthatpurpose

weuseadatasampleof1024ofthelargest

publiccompanieslistedontheEuropean

stockmarkets.

Thesampleperiodis1998-

2013.Whileanalysingtheperformanceof

companies,weaccountforanumberofbasic

nancialindicators,including:

1. Marketcapitalisation

2. Returnonequityratio(ROE)

3. Closepriceoftheshare

4. Capitalexpenditures

5. Totalrevenues

6. Total debt

7. Total equity

 Thelargestintermsofmarketcapitalisationasof

December1998.Thesamplecomprisesonlythose

publiccompaniesthatwerelistedoverthewhole

consideredperiodof1998-2013.

Thedatasetalsoincludesthefollowing

informationregardingthecompanies’CEOs

overthe1998-2013period:

• TenureoftheincumbentCEO;

• Theinformationwhethertheincumbent

CEOwasappointedfromtheoutsideor

wasaninsidersuccessor;

• ThestructureandleveloftheCEO’s

remuneration.

Weusethedatatoconstructvariables

describingtheperformanceofcompanies

(explained variables),aswellasvariables

approximatingthechannelsthroughwhich

theshort-termistbehaviourmayaffect

thecompanies’performance(explanatory

variables).

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.2.1

The companies’ performance variables (explained variables)

Thebasicmeasureofacompany’s

performancethatweuseinthisreportis

achangeinthemarketcapitalisationofarm.

Marketcapitalisationisasimpleanddirect

variableandreectsthevalueofacompany

asthemarketseesit(or,moreprecisely,

thetotalvalueofthesharesoutstanding

inapubliclytradedcompany).Herewe

assumethattheassessmentoftherm’s

performancebythemarketparticipantsis

reectedinitsshareprice,andthusinthe

marketcapitalisation.Atthesametime,

weareawarethatthemarketvalueofthe

companymaybeinuencedbythechange

intheglobalsentiment,forexampledueto

theherdingbehaviourofforeigninvestors

massivelywithdrawingcapitalfromthe

market.Weaccountforsuchsituationsby

includingcontrolvariablesinoureconometric

equations,whicharediscussedinmoredetail

intheAppendix.

Anadditionalperformanceindicatorthat

weinvestigateisthereturnonequityratio

(ROE).Itmeasuresacompany’sefciency

atgeneratingprotsfromeveryunitof

shareholderequity.Aswithmanynancial

variables,ROEisausefulindicatorwhen

comparingrmsinthesameindustry.

Consequently,intheeconometricmodelling,

amongthedifferentcontrolvariables

(describedintheAppendix)weincludethe

averageperformanceofcompaniesinagiven

sector.

Generally,ahighlevelofROEshouldbe

stronglycorrelatedwiththepositivegrowthof

thecompany’smarketcapitalisation,because

themarketparticipantstendtorewardgood

newsonthecompany’sprotsthroughan

increaseinitsshareprice.However,there

aresomefundamentaldifferencesbetween

thetwovariables.Forexample,market

capitalisationisa“stock”variablerepresenting

thevalueofacompanyandreectingitspast,

currentandexpectedactivities.ROE,onthe

otherhand,isa“ow”variablereecting

thecurrentscalyear’sperformance.ROE

maythereforebeweaklycorrelatedwithROE

indicatorsrecordedinthepreviousperiodsand

maybesubjecttomoresignicantchanges

thanmarketcapitalisation.Thesedifferences

requireaseparateeconometrictreatment,

whichisdiscussedintheAppendix.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.2.2

The impact variables (explanatory variables)

Theexplanatoryvariablesareselectedon

thebasisofthediscussionofthechannels

throughwhichshort-termismmayimpactthe

company’sperformance(seeSection3.1).

Astherstimpactvariableweconsider

thetenureoftheincumbentCEO,which

hasbeentakendirectlyfromthecollected

dataset.

AstatisticalanalysisoftheCEO

tenuresshowsthatthelackofmanagement

stabilityinEuropemaybeasourceofconcern.

Chart6illustratesthetenuredistribution

 Formoredetailsregardingourdataset,pleasereferto

theAppendix,atwww.ey.com/PL/short-termism.

ofoutgoingCEOs(outof1045withinour

sample):nearly50%ofCEOsthatleftthe

companyinthe1998-2012periodserved

forlessthan4years,whereasasmanyas

13.3%ofCEOsdidnotevenworkforonefull

yearbeforeleaving.Theaveragetenureofan

outgoingCEOoverthesampleperiodequalled

5.6years,whichisbelowtheworldaverage

(seesection3.1.1).

Chart 6. Tenures of outgoing CEOs in top listed companies in Europe

(N=1045)

0.0%

2.0%

4.0%

6.0%

8.0%

.0%

0 12345678910 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25+

49.3%

of CEOs served

for less than 4 years

Tenure of outgoing CEOs (years

)

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

* Theyellowlineindicatesthecut-offpointwheretheshareofCEOsisclosetothehalfofthesample.Lowerboundsof

thetenureintervalsarepresentedonthehorizontalaxisofthehistogram.Forexample,‘0’numberonthehorizontal

axisindicatesCEOsthatstayedintheofceforlessthanoneyear.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

Toseehowthissituationhasevolved

overtime,weanalysetheaverage(mean)

and median

tenure of outgoing CEOs

calculatedforeachyearintheanalysed

period(Chart7).

Bothmeasureschange

fromyeartoanother,howeverwithoutany

cleartendencythatmightindicateeitheran

increaseoradecreaseinthetenureofthe

outgoing CEO.

Adifferentpictureemergeswhenwe

calculatetheaverageandmediantenureof

theincumbent,insteadoftheoutgoingCEO.

Thistimeanupwardtrendisclearlyidentied.

However,whileinterpretingthelatterresult,

wemustkeepinmindthatinoursamplethere

isagroupofrmswithstablemanagement

andagroupofcompaniesthatreplacetheir

CEOsmorefrequently(whichwecansee

 Themeanisdenedasthesumofallthevaluesin

agivensampledividedbythenumberofentries.

Themedian,ontheotherhand,isthenumberthat

separatesthesampleintotwohalvesofequalnumber

ofentries.Inordertocalculatethemedian,wehaveto

sortourentriesbytheirvalues.Considerthehistogram

ofoutgoingCEOtenuresinChart6,inwhichhalfofthe

CEOsservedforlessthanfouryears,buttheaverage

tenureismuchhigherandequals5.6years.Thisis

becauseofextremecasesofthoseCEOsthatserve

foraverylongtime,whereastheshort-livedCEOsare

replacedveryoften.Asaresult,thearithmeticaverage

ishigherthantheintuitivecentraltendencyvisiblein

thehistogram.Therefore,abettermeasuretoaccount

forthatstatisticaleffectisthesamplemedian.This

measureturnsouttobeconsiderablyloweroverthe

1999-2013periodthanisthecasefortheaverage.

 Notethatwedroptheyear1998becausewedo

nothaveasufcientnumberofCEOdeparturesto

calculateanaccurateaggregatemeasureforthisyear.

verywellinChart6).Thecontributionofthe

former group to the aggregate measure of

tenureisincreasing,asthe(average)tenure

ofincumbentCEOsinthesecompaniesgets

highereachyear,whilethecontributionof

thelattergroupbecomessmallerandsmaller.

Theaveragesarenon-weighted,sothe

contributionofexperiencedCEOsisbecoming

disproportionatelyhigh,resultinginaspurious

positivedynamics.

Sincetheabovepictureisambiguous,

wecomplementthestatisticalanalysiswith

calculationsoftheCEOturnoverrates“over

the1999-2012period.Chart8showsneither

anupwardnordownwardtendencyinthis

area.Insteadweseearelativelystablefraction

ofcompaniesappointinganewCEOinagiven

ye a r.

Chart 7. Average and median tenure of the outgoing CEO (left panel)

and the incumbent CEO (right panel)

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Outgoing CEO tenure sample average

Outgoing CEO tenure sample median

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

CEO tenure sample average

CEO tenure sample median

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

Chart 8. CEO turnover rates (the share of rms replacing their CEO

in a given year)

11.9%

15.2%

15.8%

15.3%

11.6%

12.3%

14.4%

14.3%

15.5%

12.0%

11.6%

12.3%

11.1%

14.1

10%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

Forthepurposeofouranalysis,thetenure

oftheincumbentCEOisabetterexplanatory

variablethanthetenureoftheoutgoing

CEO.Thisisbecausethelattervariablecan

beobservedonlyoccasionally,whenanew

CEOisappointed.Moreover,forsomerms

(withthesameCEOoverthewholesample

period)thisvariablewouldnotbeobservedat

all.Consequently,wewouldhavetoremove

manyrmswiththemoststablemanagement

from our sample. This problem does not apply

tothetenureoftheincumbentCEOasan

explanatoryvariable,whichisobservedfor

eachanalysedcompanyineverysingleperiod.

WealsoverifywhetherthetenureoftheCEO

mayberelatedtothecountry-speciccultural

factors.ForthatpurposeweapplytheLong-

TermOrientationIndexofHofstedeetal.

(2010),

showingthedifferenttime

 GeertHofstede,GertJanHofstede,MichaelMinkov

(2010),CulturesandOrganizations3rdedition2010,

McGraw-Hill.DimensionDataMatrixavailableonlineat

www.geerthofstede.nl/dimension-data-matrix.

orientationofdifferentcultures.Ahighvalue

ofthatindexisassignedtocultureswithlong-

termorientationthatworktowardsfuture

goals,whilealowvalueisassociatedwith

cultureswithshort-termorientationthatare

concernedwiththepastandpresent.Welist

thecountries,whosestockexchangesare

includedinoursample,andrankthemfrom

thelowesttothehighestvalueoftheLong-

TermOrientationIndex.Next,dependingon

thelocationofthemajorstockexchangefor

agivencompanyfromoursample,weassign

eachcompanytoitsrespectivecountry.

Thisallowsustoconstructacumulative

distributionfunctionanddistinguishfour

distinctgroupsofcountries,rankedfrom

thelowesttothehighestleveloftheIndex

(Chart9).Finally,foreachoftheabovegroups

wecalculatetheaveragetenureoftheCEO.

Interestingly,asillustratedinChart10,wedo

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

notndanyrelationbetweenthetime-

orientationofculturesandtheaveragetenure

ofexecutives.Thisfurtherstrengthensthe

hypothesisthat,asfaraslistedcompanies

areconcerned,short-termismhasbecome

aglobal,culture-widephenomenon.

Chart 9. Empirical cumulative distribution function for the Long-Term

Orientation Index

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Source: EY calculation based on data from SPIQ, Thomson Reuters and Hofstede et al. (2010).

Chart 10. Average time in the role among the rms from countries with

the lowest and the highest values of the long-term vs. short-

term orientation index, in comparison to the sample average

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Group with the lowest Hofstede Index Sample average

Group with the highest Hofstede Index

Source: EY calculations based on data from SPIQ, Thomson Reuters, Boardex and Hofstede et al. (2010).

 Hofstedeetal.,op.cit.

Short-termism in business: causes, mechanisms, consequences

Thesecondexplanatoryvariableusedin

ouranalysisisthecompany’sinvestment

activity.Obtainingthisvariablehasrequired

some additional transformations. In order to

accountforthedifferentsizesoftheanalysed

companies,wehavecalculatedtheinvestment

activityvariableascapitalexpenditure

dividedbythetotalrevenueortotalassets

(approximatedbythesumoftotaldebtand

totalequity).

Inbothvariants,theanalysed

 Thetotalrevenueshavebeentakenfromthecurrent

year,whereasthevalueofthetotalassetshasbeen

takenfromtheendofthepreviousyear.

measureofinvestmentactivitydecreased

overthe1999-2012period(Chart11).

Interestingly,suchastrongdownward

tendencywasnotrelatedtoadecreasein

thecapitalexpendituresinabsoluteterms.In

fact,expenditureincreasedoverthe1999-

2012period,butataratefarslowerthanthe

increaseintotalrevenuesandtotalassets,

whicharethedenominatorsoftheanalysed

ratios.

 Whereasthesampleperiodstartsin1998,Chart11

beginsin1999.Thisisbecauseweusethelagged

valueforthetotalassets–seethepreviousfootnote.

Chart 11. Capital expenditures to total revenue and to total assets ratios

10%

12%

14%

16%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Capital expenditures to total revenue Capital expenditures to total assets

Source: EY calculations based on data from SPIQ and Thomson Reuters.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Weusecompanyinvestmentactivityasan

explanatory,butalsoasanexplainedvariable.In

theformersituationweanalysetowhatextent

thecapitaloutlaysinuencethecompany’s

performanceintheshort-andlong-term.

However,shouldthatimpactturnouttobe

signicant,wewouldalsobeinterestedin

investigatingwhether,forexample,theCEO

tenureorothervariablesaffecttherm’s

propensitytoinvest.Weaddressthisissueinour

econometricexercisebyincludinginvestment

activityasaperformancevariable.

Anotherissuethatweinvestigateiswhetherit

mattersfortheperformanceofthecompany

whethertheCEOwasappointedfromthe

outsideorwasaninsidersuccessor.Thelatter

shouldhavemoreknowledgeofhowthe

companyfunctionswhereastheformermay

bringafreshperspectivetotherm.Wetest

empiricallytherelativeimportanceofthese

factors,bothforthecompany’sperformance

andinvestmentactivity.

Yetanotherexplanatoryvariableusedin

ouranalysisisthestructureoftheCEO’s

remuneration.Forthatpurposeweusedata

onconditionalcompensationofexecutivesin

theformoflong-termincentiveplans(LTIPs).

HerewedeneLTIPasapartoftheexecutives’

remunerationthatispaidinshares,optionsor

cash,butrequiresacertainconditiontobemet

beforetheawardismade.Thisconditionshould

berelatedtothelonger-termperformanceof

thecompany.Chart12illustratesthatinour

samplethisformofremuneratingexecutives

hasbeenincreasinginimportance.Wetherefore

investigatewhethertheLTIPshareinthe

overallremunerationoftheCEOmattersforthe

company’sperformance.However,duetothe

problemofendogeneity,weanalysethisvariable

intheshort-termmodelonly(formoredetails

seetheAppendix).

Chart 12. Average share of LTIP in the overall remuneration of the CEO

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

Theremainingexplanatoryvariablesincludelaggedexplainedvariablesaswellassectoralcontrol

variables,whicharediscussedinmoredetailintheAppendix

 Sinceoursampledoesnotincludedataonthecompanies’employment,wedonotanalysethe“humancapital”channelin

theempiricalpartofthestudy.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

3.2.3

Statistical analysis

Tomeasuretheimpactofshort-termism

onacompany’sperformance,weusetwo

differentmethods:descriptivestatistical

analysisandeconometricmodelling.Simple

descriptivestatisticalanalysisisbased

onacomparisonoftheaveragesofthe

performanceindicatorsacrossparticular

subsamples(relatedtotheimpactvariables).

Econometricmodelling(oreconometrics)is

theapplicationofformalisedmathematical

methodsinordertondeconomic(causal)

relationshipswithinthedata.Inotherwords,

econometricsisatoolkitofquantifying

theimpactofagivenexplanatoryvariable

(oragroupofvariables)onsomeexplained

variable.Wediscussthegeneralmeritsof

econometricsinFrame2,whereasthedetails

ofthemodelsconstructedforthepurposeof

thisstudyareoutlinedintheAppendix.

Westarttheempiricalanalysisoftheimpactof

CEOtenureonthecompany’sperformanceby

calculatingthemarketcapitalisationforeach

companyineverysingleyearofthesample

period(1998-2013)andcomparehowthe

marketvalueevolvedovertimeforthethree

groupsofrms:

• 25%ofrmsthatreplacedtheirCEOs

mostfrequentlyoverthe1998-2013

period(i.e.companieswiththeleast

stablemanagement)

• Theoverallsample

• 25%ofrmsthatreplacedtheirCEOs

leastfrequentlyoverthe1998-2013

period(i.e.companieswiththemost

stablemanagement,seeChart13)

Chart 13. Market capitalisation index over the 1998-2013 period against

frequency of the CEO replacements (1998=100)

100

200

300

400

500

600

700

800

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

25% of companies with the least stable management (average tenure 2.17 years)

The overall sample (average tenure 5.68 years)

25% of ﬁrms that replaced their CEOs least frequently (average tenure 11.38 years)

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Wendthatthemarketcapitalisationof

companieswhoseCEOsarecharacterisedby

thelongesttenure(11.4yearsonaverage)

increasedmorethanthemarketvalueofrms

withlessstabletopmanagement.Thedifference

isparticularlyremarkableinthecaseofthe

25%ofrmsmostfrequentlyreplacingtheir

CEOs(withanaveragetenureof2.2years)–the

increaseintheircapitalisationisonlyhalfofthat

recordedforthermsthatenjoyedthemost

stable management.

Interestingly,thedifferenceintheperformance

ofcompanieswiththemoststablemanagement

andthesampleaverageismuchsmallerthan

betweenthesampleaverageandcompanies

thatmostfrequentlyreplacetheirCEOs.This

suggeststhatcompaniesgainalotfroman

increaseintheCEO’sexperience,butthese

benetsareparticularlystrongduringtherst

yearsoftheCEO’stenure,whereaslaterthey

continuetogrow,butatamoremoderatepace.

Wealsocomparetheperformanceofthe

variousgroupsofrms,categorisedbytheir

managementstability,withrespecttothe

averagevalueofROEoverthe1998-2013

period.ROEincompanieswithmoststable

managementturnsouttobealmosttwiceas

highasinthecaseofthermsmostfrequently

replacingtheirCEOs(14.4%vs.7.3%,Chart14).

Again,companiesappeartobenetfromCEO

stability.

Chart 14. Average ROE over period 2005-2013 against the frequency of CEO

replacements

7.3%

10.2%

14.4%

% of ﬁrms most frequently

replacing CEOs

Sample averag

% of ﬁrms most rarely replacing CEOs

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Anothervariablethatisinvestigatedin

ourempiricalstudyisinvestmentactivity.

WeanalysetherelationshipbetweentheCEO’s

tenureandtherm’sinvestmentexpenditure,

aswellastheimpactofcapitaloutlayson

theperformanceofthecompany.Chart15

illustratesinvestmentactivityofdifferent

groupsofrmsoverthe1998-2013period,

categoriseddependingontheirmanagement

stability.

Chart 15. Capital expenditure to total revenue ratio against the frequency

of CEO replacements

8.2%

9.0%

9.4%

25% of ﬁrms most frequently

replacing CEOs

Sample average

25% of ﬁrms most rarely replacing CEOs

Source: EY calculations based on data from SPIQ, Thomson Reuters and Boardex.

TheEuropeanrmswiththemoststable

managementdevoteahigherproportion

oftheirtotalrevenuetoinvestmentoutlays

thancompanieswithahigherturnoverof

theirCEO.Onaverage,25%ofrmsleast

frequentlyreplacingCEOshad1.2p.p.higher

capitalexpendituretototalrevenueratiothan

companieswiththehighestturnoverrate.

Thismightsuggestthatlackofmanagement

stabilitymayleadtoneglectintheinvestment

activityoftherm.

Theabovestatisticalresults,whilehelpfulin

formulatingsomeintuitivehypotheses,donot

allowustodrawanyconclusionsasregards

thecausalityandstrengthoftherelationship

betweentheCEO’stenureandthecompany’s

performance.Suchananalysisrequiresthe

useofeconometricmethods.Theseare

discussedinmoredetailintheAppendixtothis

report,whileinthenextsectionwepresent

only the main results.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.2.4

Summary of the econometric results

Astheproblemofshort-termismhinges

upontheinappropriatebalancebetween

pursuing the short-term and long-term goals

ofacompany,inoureconometricapproachwe

havedistinguishedtwomodellingtechniques,

allowingustoseparatetheshort-runandthe

long-runrelationshipsbetweentheanalysed

variables.Theshort-termapproachisbasedon

panelmodels,whereasthelong-termapproach

usescross-sectionmodels(seeFrame2andthe

Appendix).Intotal,11panelmodels(5models

ofthemarketcap,3modelsofROE,and3

modelsexplainingthecapitalexpendituresto

totalrevenueratio)and8cross-sectionmodels

(2modelsofthemarketcap,2modelsofROE,

2modelsexplainingthecapitalexpendituresto

totalrevenueratio,and2modelsexplainingthe

capitalexpenditurestototalassetsratio)have

beenestimated.Therearetworeasonswhywe

haveincludedsomanymodelsintheanalysis:

(1)theneedforrobustnesschecks,and(2)the

needtoapplyadifferenteconometricapproach,

wheretheresultsofeconometrictesting

proceduresrequiredthatourinitialapproachbe

adapted.

Themostimportantresultsoftheeconometric

analysis,bothfortheCEOtenureandthe

investmentanalysis,aresummarisedinChart

16(formarketcapitalisationastheperformance

variable)andChart17(forROE).Inthosecharts

wedistinguishshort-andlong-termvariantsof

theperformancevariable.Weindicatepositive

andstatisticallysignicantrelationshipswith

bubblesincluding“+”,negativeandstatistically

signicantrelationshipswithbubblesincluding

“-”andstatisticallyinsignicantrelationships

withbubblescontaining“?”.

Short-termism in business: causes, mechanisms, consequences

Frame 2

Why do we use econometrics?

Themainreasonsforusingeconometrics

inthisstudyisitsabilitytoassigneconomic

meaningtothecorrelationsfoundinthe

data,thepossibilitytodistinguishshort-term

andlong-termeffects,aswellasthegood

treatmentofunobservablevariablesand

one-offs.Mostoftheseadvantagesarerelated

to the use of panel data ineconometric

modelling–panel data econometrics. The

termpaneldatareferstodatasetsthathave

morethanonedimension,usuallytwo:the

entities(countries,individualsorcompanies)

andthetimeoverwhichtheseentitiesare

observed.Everyvariable(e.g.CEOtenure)

isconsideredinthesedimensions,i.e.we

knowthevalueofsuchavariablebothfor

aparticularcompanyandaparticularyear.

Wediscusstheadvantagesofpaneldata

econometricsbelow.

Seeking economic meaning in correlations

Descriptivestatisticalanalysis,asusedin

thisstudy,saysalotaboutthedata,butit

isusuallyimpropertoinferabouteconomic

relationshipsonthatbasisalone,duetosuch

thingsassectoraldifferencesbetweenrms,

whichalsohavetobetakenintoaccount.

Forinstance,somesectorstendtobemore

capitalintensivethanothers.Therefore,

armfromaheavyindustrialsectorwill

haveadifferent‘natural’levelofinvestment

activitytoacompanyfromtheretailtrade

sector,makingthesetwormsincomparable.

However,ifweanalysebothrmsinrelation

totheirsectoralbenchmarks,wearethen

abletocomparethemwithrespecttotheir

investmentactivity.Tofullyaccountforsuch

kindsofdifferences,itisnecessarytodivide

thermsintoaverylargenumberofgroups,

andthencomparetheirperformance,making

itdifculttodrawgeneralconclusionsfrom

thedataset.Contrarytodescriptivestatistical

analysis,suchproblemscaneasilybesolved

witheconometrics.

Unobservable variables

Somecompanycharacteristicsareeither

unavailableinourdatasetorareimpossibleto

quantifyatall.Ineconometrics,werefer

tosuchvariablesasunobservablevariables.

Inthecaseofthisstudy,agoodexampleis

thecompanycorporateculture,whichcan

bediscussedonlyinqualitativeterms.Aswe

havemorethan1000rmsinoursample,we

cannottellthestoryofthecorporateculture

ofeverysinglecompanywithoutasubstantial

lossofimportantdetail.Thisiswhy,from

thepointofviewofquantitativemethods,

it is sometimes reasonable to say that the

corporatecultureisunobservable.Paneldata

econometricseasilytacklesthisissue.

Toseethemeritsofpaneldatahere,imagine

thatoursamplewaslimitedtojustonesingle

year.Inthatcase,manyoftherelations

apparentinthedatawouldbespurious.For

instance,wecouldconfusethebenetsfrom

aparticularcorporateculture(whichisroughly

constantovertime)withtheimpactofthe

decisionsoftheparticularCEO.However,ifwe

considerthesamecompanyattwodifferent

pointsoftime,wecanobservetheincrement

ofthetenurewiththecorporateculture

roughlyunchanged.Becauseinthepaneldata

wehavebothtimeandindividualdimensions,

wecanstudythedifferencesbetween

companies,aswellasdevelopmentsinasingle

companyovertime.

Short-term vs. long-term effects

Short-termism is essentially the problem of

animbalancebetweenachievinglong-term

andshort-termgoals.Withapaneldataset

givingbothtimeandcompanydimensions,

econometricmethodshelpmakethese

differencesmoreformal–identifyingtheshort-

termandlong-termaspectsofthephenomena

discussedabove.

One-offs

Selectingonesingleyearforourstudy

couldbringusincidentalresultsduetosome

random,one-offevents.Aswestudyour

sampleover16years,suchaccidentalfactors

areaveragedoutinthepaneleconometric

models.Thispropertygivesusmoreprecise

estimatesoftheeconomicprocessesapparent

withinoursample.

 Fortheshort-termeffects,weusepanelregressions,

whereastocapturelong-termrelationsweruncross-

sectionregressions(whichinthiscasearealsopartof

thepaneldataeconometrics).

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

Chart 16. The impact of time in the role and investment activity on the long-

term performance of a rm – market value

Short-term market

capitalization growth

CEO tenure

Capital

expenditures

Long-term market

capitalization growth

statistically signiﬁcant positive impact no clear impact

statistically signiﬁcant negative impact

Source: EY econometric analysis based on data from SPIQ,

Thomson Reuters and Boardex. For more details see the Appendix.

Themainconclusionsfromtheeconometricmodellingareasfollows:

CEO tenure has a positive inuence on

the market capitalisation of

a company. Whereasintheshortterm,

thiseffectisnotalwaysstatistically

signicant,theevidenceismuch

strongerinthecaseofthecompany’s

long-termvalue.Theselong-termeffects

arenon-linear:theimpactofCEOtenure

onlong-termmarketcapitalisationis

positive,buttendstoweakenwithan

increasingCEOtenure(asillustratedby

Chart19).Thisthereforeconrmsthe

hypothesisformulatedinsection3.2.3

thatthemarginalbenetsfromevery

additionalyearintheCEO’schairare

decreasing.

The positive effects of CEO tenure are

even more evident when analysing its

impact on the company’s ROE.Here

thepositiveeffectsarestrongand

statisticallysignicantbothintheshort

andlongterm.Accordingtoestimation

results,anadditionalyearofCEOtenure

leads,inthelong-run,toanaverage

increaseinthecompany’sannual

protabilityby0.3p.p.

Short-termism in business: causes, mechanisms, consequences

In the long-term, both the company’s

market capitalisation and the

average ROE are positively

inuenced by the rm’s investment

activity.Ariseincapitalexpenditures

tototalassetsratioby10p.p.inthe

long-termleadstoanincreaseinthe

averageROEby4.5p.p.,whilearisein

capitalexpenditurestototalrevenue

ratioby10p.p.leads,inthelong-run

(here15years),toanaverageincrease

inthegrowthofthecompany’smarket

capitalisationby7.1p.p.

However, in

the short-run, an increase in

investment expenditure negatively

affects the market capitalisation of

the company. Increasingthecapital

expenditurestototalrevenueratioby

10p.p.leadstoashort-term

decelerationofthecompany’smarket

capitalisationby1.6-3.9p.p.(in

averageterms;therangeoftheeffect

reectingtheresultsofthevarious

modelsconsidered).Wetherefore

provideevidencesupportingthe

hypothesis(formulatedinsection

3.1.2)thatexecutivesfocusingon

short-termresultsmayneglect

investmentexpenditure,

notwithstandingthecoststhatitmay

entailforthecompanyinthelonger

term.

Withrespecttothat,itisparticularly

interestinghowCEOtenureinuences

thecompany’spropensitytoinvest.Our

estimationresultsshowthatthe longer

the CEO tenure, the higher (on

average) are the company’s

investment outlays.Inparticular,an

additionalyearofCEOtenureleads,on

average,toanincreaseintherm’s

capitalexpendituretototalrevenues

ratioby0.2p.p.(thesameresulthas

beenobtainedforthecapital

expendituretototalassetsratio).

 Ithastobenoted,however,thatthelatterrelationship

issubjecttoasubstantialestimationerror–formore

detailsseetheAppendixatwww.ey.com/PL/short-

termism.

Therefore,ourresultsindicatethat

there are two channels through which

the CEO tenure affects the

company’s performance: (1) a direct

positive impact of the executive’s

experience and (2) an indirect impact

on CEO tenure through the positive

effect on investment activity,which

improvesthecompany’slong-term

performance.Consequently,the

worldwidetendencyofshorteningCEO

tenurehastobeassessednegatively.

WhereasinoursampleofEuropean

companiesnosuchdecliningtendency

hasbeenobserved,thelowaverage

levelofCEOtenureinthesermsisin

itselfasourceofconcern.

Inadditiontotheabovevariables,we

havealsoanalysedwhetheritmatters

iftheCEOwasappointedfromthe

outsideorwasaninsidersuccessor.

Our estimation results point to

a positive impact of appointing an

insider successor on the company’s

ROE, both in the short and long

term.Itmayreectanadditional

dimensionoftheCEO’svaluable

experienceasthatofthecompany’s

insider. This effect is also identied in

terms of the positive impact on the

company’s market capitalisation in

the short term,thoughitisnot

statisticallysignicantinallmodel

specications.Moreover,we do not

nd the outsider effect on the

company’s long-term market value.

Neither have we identied any

impact of an outsider or insider

successor on the company’s

investment activity.

Theconsequencesofshort-termism

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

Finally,amongtheexplanatoryvariables

ofthecompany’sperformance,wehave

includedtheLTIPshareintheCEO’s

overallremuneration.Theobtained

resultsindicatethatincreasing the role

of the LTIP in the remuneration

scheme positively inuences the

company’s ROE in the short term.

That effect, however, has not been

identied for the market capitalisation

or investment activity of the company.

Duetotheendogeneityproblem,we

havenotanalysedtheimpactofthe

executives’remunerationschemeonthe

company’slong-termperformance(for

moredetailsonthatseetheAppendix).

Chart 17. The impact of time in the role and investment activity on the long-

term performance of a rm – ROE

Short-term ROE

CEO tenure

Capital

expenditures

Sustained improvement

in ROE

statistically signiﬁcant positive impact no clear impact

statistically signiﬁcant negative impact

Source: EY econometric analysis based on based on data from SPIQ,

Thomson Reuters and Boardex. For more details see the Appendix.

Chart 18. The benets from every additional year in the CEO’s chair according

to the long-term econometric model explaining the market cap

The impact on the market cap long-term

dynamics

Time in role

Source: EY econometric analysis based on data from SPIQ,

Thomson Reuters and Boardex. For more details see the Appendix.

Short-termism in business: causes, mechanisms, consequences

Theconsequencesofshort-termism

3.2.5

Summary of the empirical analysis

Ourempiricalanalysishasempirically

conrmedsometheoreticalndingsofthe

literatureonshort-termism.Inparticular,

totheextentthattheexternalpressure

ofinvestorsonshort-termresultsleadsto

theshorteningoftheexecutives’average

tenure,wehaveshownthatthisnegatively

affectstheperformanceofthecompanyand

undermines its long-term fundamentals. Our

resultsshowthattheexperienceoftheCEO

isassociatedwiththebetterperformanceof

thecompany.Thiseffect,however,becomes

weakerwiththeincreasingtenureofthe

executive,whichindicatesthedecreasing

marginalbenetsfromeveryadditionalyear

oftheCEO’sexperience.Moreover,weidentify

anadditional,indirectimpactoftheexecutive’s

experienceonthecompany’sperformance.

Ittakesplacethroughtheinvestmentchannel,

sincethelongertheCEO’stenure,thehigher

therm’scapitalexpenditure.Investment

activity,inturn,increasesthecompany’s

protabilityandvalueinthelongterm.

Intheshort-run,however,increasedcapital

outlaysleadtoadeclineinthecompany’s

marketcapitalisation.This,inturn,may

reinforcetheneglectofinvestmentactivityby

executiveswhofocusonmaximisingtheshort-

termperformanceofthecompanyanddonot

paymuchattentiontothelong-termcoststhat

suchdecisionsentail.

Theconsequencesofshort-termistbehaviour

donotjustboildowntoindividualrms.Short

CEOtenureandneglectofinvestmentoutlays

decreaseacompany’slong-termvalueand

protability,aswellastheirabilitytoadapt

tonewmarketconditionsandtocompeteon

aglobalscale.Inthisway,ifshort-termism

affectsmanyrms,ittranslatesintothe

reducedpotentialoftheentireeconomy

(Chart19).Moreover,asalreadydiscussedin

Frame1,excessivefocusonshort-termgoals

bymanyrmsandinstitutionsmayleadto

systemicrisk,affectingthestabilityofthe

entireeconomicsystem.Thishasbecome

evident,especiallyinthecaseoflargenancial

institutions issuing subprime mortgages

allowingthemtomakefastbutunsustainable

prots.Thisledtothehousingbubble,the

burstofwhichresultedintheglobaleconomic

crisis(seeFrame1).Therefore,short-termism

mayleadtomacroeconomicimbalancesthat

oftenresultinasuddeneconomicdownturn.

Chart 19. Direct symptoms of short-termism in management

Short-termism

Short CEO tenure Neglect of investments

Decrease in companies’

ability to adapt to new

market conditions and

to compete on a global scale

Inefﬁcient allocation

of capital, decline in companies'

value in the long-term

Weakening of

economic potential

Source: EY.

Section 04

Conclusions

Short-termism in business: causes, mechanisms, consequences

Thereisalotofevidence,notleastthe

recentnancialcrisis,toshowthatlong-term

objectiveshaveoftenbeenneglectedbecause

oftoomuchconcentrationonshort-term

goals.Thisistheshort-termismphenomenon,

whichisparticularlyvisibleinthecaseofpublic

companies,whichareoftenunderpressure

fromtheirshareholderstodelivershort-term

outcomes.Amongthefactorsthatcontributed

tothispressurearenewtechnologies,reduced

tradingtimesandtransactioncosts,market

volatility,mediacoverage,andtheincreasing

roleofinstitutionalinvestors.

Ontheonehand,onemightclaimthat

executivesshouldnotsubmittoinvestor

pressure,andshouldsimplymaintainthe

balancebetweenlong-,medium-andshort-

termgoals.Ontheotherhand,however,

shareholdershaveinstrumentstoeffectively

executetheirexpectationsofshort-term

outcomes.Theseinstrumentsincludeshaping

theremunerationschemesoftheexecutives

basedontheirshort-termperformance,aswell

astheabilitytoremoveexecutivesfromofce

iftheydonotmeetinvestorexpectations.The

short-termistbehaviourisfurtherreinforced

bycompanies’marketcommunicationsand

nancialreportingpractices,whichlargely

focusontheshort-termperformanceand

areusedbyinvestorsasaninstrumentto

monitortherealisationoftheirexpectations.

Consequently,short-termismoftenresultsin

“earnings management” rather than building

thelonger-termvalueofthecompany.

Wehavedistinguishedthreedifferentchannels

throughwhichshort-termismmayadversely

affectcompaniesandtheeconomyasawhole.

Theseare:shortenedCEOtenure,neglect

ofinvestmentactivityandneglectofhuman

capital.Intheempiricalanalysiswefocuson

theformertwo.

Literatureprovidesevidencethattherehas

beenasignicantshorteningofexecutives’

contractsandperformanceevaluation

intervals.Insuchasetting,CEOsmayhave

astrongincentivetofocusonshort-term

outcomesthatwillmaterialiseduringtheir

expectedtenure,notwithstandingthelong-

termconsequencesoftheirdecisions.This

tendencymayhavebeenreinforcedbythe

factthatinvestmentportfoliosthatperform

welloverthelong-termdonotguaranteethat

periodsofshort-termunderperformancewill

beavoided,whileitisshort-termtargetsthat

oftenconstitutethebasisoftheexecutives’

performanceassessment.

Oureconometricanalysishasconrmedthat

addressing the issue of management stability

shouldbeofgreatimportance.Theresults

ofourresearchshowthatanincreasedCEO

tenurepositivelyinuencesthecompany’s

protabilityandmarketcapitalisation.The

impactonthelong-termvalueofthecompany

tendstoweakenwithanincreasingCEO

tenure,whichindicatesthatthemarginal

benetsfromextendingthelengthofthe

executive’scontractareparticularlystrong

intherstadditionalyearsoftheCEO’s

experience.

Areductionininvestmentexpenditures

isanotherimportantchannelofthe

impactofshort-termismonacompany’s

performance.Capitaloutlaysmadewith

theaimofimprovingtherm’slong-term

competitivenessandcapacitymay,inthe

short-term,leadtoadeteriorationinreported

nancialindicators,whichinturnmayresult

inadeclineinthecompany’sshareprice.

Thishasbeenconrmedbyourempirical

analysis,whichshowsthatanincreasing

investmentexpenditureleadstoashort-term

dropinthecompany’smarketcapitalisation.

Therefore,whileexecutivesrecognisethe

problemofexcessiveshort-termism,they

maybereluctanttoallocatecapitaltoaddress

long-termissues,becausetheydonotwant

tomisstheshort-termconsensusestimate

Conclusions

Short-termism in business: causes, mechanisms, consequences

Conclusions

anddisappointinvestors.Availablesurvey

resultsconrmthatexecutiveswoulddelay

orsacriceprojectscreatinglong-termvalue

in order not to miss short-term earnings

targets.Thisisaseriousconsequenceofshort-

termism,conrmedbyourempiricalanalysis,

whichshowsthatneglectinginvestment

activityreducesthecompany’slong-termvalue

andaverageprotability.Withrespecttothat,

animportantndingofourresearchisthat

managementstabilityisconducivetohigher

investmentactivityinacompany,whichinturn

increasesthelong-termvalueoftherm.

Wehaveshownthattherearetwochannels

throughwhichCEOtenureaffectsthe

company’sperformance:(1)adirectpositive

impactoftheexecutive’sexperience,and

(2)anindirectimpactofCEOtenurethrough

thepositiveeffectoninvestmentactivity.

Therefore,theworldwidetendencyof

shortening CEO tenure has to be assessed

negatively.WhereasinoursampleofEuropean

companiesnosuchdecliningtendencyhasbeen

observed,thelowaveragelevelofCEOtenure

inthesermsisinitselfasourceofconcern.

Consequently,tacklingtheproblemofthe

shortenedexecutivescontractsmaybeoneway

of addressing the issue of short-termism.

ShortCEOtenureandneglectofinvestment

outlaysdecreaseacompany’slong-termvalue

andprotability,aswellastheabilitytoadapt

tonewmarketconditionsandcompeteon

aglobalscale.Inthisway,ifshort-termism

affectsmanyrms,ittranslatesintothe

reducedpotentialoftheentireeconomy.

Moreover,excessivefocusonshort-termgoals

bymanyrmsandinstitutionsmayleadto

systemicrisk,affectingthestabilityofthe

entireeconomicsystem.Thisriskisreinforced

bytheherd-likementalityofinstitutional

investors,whichmayfeedassetprice

bubbles.

 RafaeleDellaCroce,FionaStewart,JuanYermo

(2011),Promoting Longer-Term Investment by

Institutional Investors: Selected Issues and Policies,

OECDJournal:FinancialMarketandTrends,Issue1.

Thecostsofshort-termismmaytherefore

besignicant,andallpossibleactionsaimed

at addressing this issue should be of great

importance,notleasttopolicy-makers.While

thisreporthasfocusedontheimpactofshort-

termismonacompany’sperformanceand

notonthemeasuresthatcouldbeadopted

tocounterthisproblem,thelatterarebriey

discussedbelow.Atthesametime,ithasto

be emphasised that the list of the presented

measuresisnotcomplete.Itsimplyprovides

examplesofactionsthatarerecommendedby

certainauthors,andthusdoesnotnecessarily

representEY’srecommendations.

Firstofall,themechanismsunderlyingshort-

termistbehaviourclearlyshowthatreducing

the problem of short-termism requires the

involvementofallstakeholders.Inparticular,

executivesexcessivelyfocusontheshort-

termperformanceinresponsetomarket

expectationsandpressurefrominvestors.

Engagementwiththeinvestorcommunity

should therefore be an important part of the

strategytocountertheproblemofshort-

termism.Forexecutivestoeffectivelybalance

short-andlong-termobjectives,theyneed

tocooperatewithandcreateunderstanding

amongkeyexternalstakeholders.Indeed,

Ecclesetal.(2012)

showthatcompanies

thataremorelikelytohaveorganised

proceduresforstakeholderengagement

aremorelong-termoriented,exhibitmore

measurementanddisclosureofnon-nancial

information,andsignicantlyoutperformtheir

counterpartsoverthelongterm,bothonthe

stockmarketandinaccountingperformance.

Onewayofimprovingcommunicationwith

stakeholdersmayberelatedtochangesinthe

reportingframework,inparticularamending

thestructureofinformationtowardsmore

 RobertG.Eccles,IoannisIoannou,andGeorge

Serafeim(2012),The Impact of a Corporate Culture

of Sustainability on Corporate Behaviour and

Performance, HarvardBusinessSchoolWorkingPaper

12-035,–quotedinCFAInstitute(2012),“Visionary

BoardLeadership.StewardshipfortheLongTerm”.

Short-termism in business: causes, mechanisms, consequences

long-term,fundamentalguidance.This

mayhelpinshiftingthefocusofinvestors

towardsthelong-termvalueandtruedrivers

ofbusinesssuccess,aswellasattractnew,

long-terminvestors.Anotherwaytoreduce

themarketfocusonshort-termperformance,

assuggestedbysomeauthors,

might be less

frequentreportingonacompany’snancial

performance.Moreover,manycompaniesdo

notpublishearningsguidancebecauseitmay

reveallittleabouttherm’strueeconomic

performance.Instead,theyemphasisefactors

thatshouldberelevantinappraisingbusiness

value.

Shiftingthecommunicationbalanceinfavour

of long-term fundamentals requires setting

anddisclosinglong-termgoals,strategiesand

actionsthatthermistoundertake.Reports

publishedbycompaniesshouldthenoutline

theprogresstowardsachievinglong-term

objectives.

Anotherwaytoaddressexcessiveshort-

termismistoincentiviseexecutivestopay

moreattentiontolong-termvaluecreation.

Thismaybeachievedthroughstructuringthe

remunerationschemesofexecutivessothat

asignicantportionoftheircompensation

isbasedonthelong-termperformanceofthe

company.Thismaytaketheformofdiffered

compensationarrangementsorLong-Term

IncentivePlansrequiringaconditiontobemet

beforetheawardisgranted.Itisimportant

thatvestingperiodsforincentivepayarelong

enoughtoencouragealonger-termfocus,

 Pocock,op.cit.

 See,e.g.,MichaelJMauboussin(2006),Approaching

Level 10: The Story of Berkshire Hathaway, reproduced

inRappaport(2006),op.cit.

sincepoorlong-termperformancemay

reducethevalueofearlierincentiveawards

beforetheycanbecashedoutorexcercised.

Incontrast,ifexecutivesownstockoptions

withshortvestingperiods,thismightstimulate

actionstoboostshort-termperformance,

becauseitwouldallowexecutivestobenet

from selling their holdings before the long-

termcostsoftheirdecisionsmaterialise.Such

remunerationschemesarethereforelikely

totriggertheexcessivefocusoftheCEOon

acompany’sshort-termresults.

Similarly,theshort-termistbehaviourof

investorsmightbetemperedbyproviding

incentivesforlong-durationholdingsof

securities,anddisincentivesforshort-duration

holdings.Assuggested,forexample,by

HaldaneandDavies,

these measures may

taketheformoftaxand/orsubsidies,or

governancemeasureslinkingvotingrightsto

the duration of equity holdings.

Takingintoaccountthecoststhatshort-

termismentails,notonlyforpubliccompanies,

butalsoforthewholeeconomy,westrongly

recommendconsideringthemeasuresoutlined

above,aswellasotherinstrumentsthatmay

helptoaddresstheexcessivefocusonshort-

termgoals.Ifdealtwitheffectively,itwould

improvethecapacityandcompetitiveness

ofnationalbusinesses,encouragelong-term

valuecreationandcontributetothewelfareof

society.

 BrianGMMain,RolfThiessandVickyWright(2010),

Career Shares as Long Term Incentives, Universityof

EdinburghBusinessSchool(Edinburgh)andTowers

Watson(London).

 HaldaneandDavies,op.cit.

Conclusions

The authors

EY Poland, Economic Analysis Team

BartoszOlesiński

PawełOpala

MarekRozkrut

AndrzejTorój

Contact

JacekKędzior

CountryManagingPartner,Poland

Tel.: +48225577284

Fax: +48225577001

Email: Jacek.K[email protected].com

MarekRozkrut,Ph.D.

Partner,ChiefEconomist

EconomicAnalysisTeam

Tel.: +48225576411

Fax: +48225577001

Email: Marek.R[email protected]y.com

TheauthorsaregratefultoPaulinaAdamczykandPiotr

Roszkowskiforexcellentresearchassistance,andto

MichałGrzybowski,KarolinaKonopczakandKarol

Raźniewskiforvaluablesuggestionsanddiscussions.

Theauthorswouldalsoliketothankprof.Geert

Hofstedewhohaskindlyagreedtoapplyhisndingson

long-termorientationofculturesinthisstudy.

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