Corporate short-termism

[Simfan34]

BlackRock's CEO wrote an open letter about this a few months ago, arguing that it was one of the largest problems affecting the economy today. I am inclined to agree. In the past I've talked about the failure of firms to invest in basic research, and bow I think we see the proliferation of buybacks and dividends eat up much of that revenue in many companies. One solution possibly would be to adjust the capital gains tax structure to penalize short term stock holding and incentivise long term holding.

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http://mobile.nytimes.com/2015/04/14/business/dealbook/blackrocks-chief-laurence-fink-urges-other-ceos-to-stop-being-so-nice-to-investors.html?referrer=

Back in the 1970s the average shareholder held on to their stock for around 7 years... I believe that number is today in the area of six months. Firms shoot themselves in the foot by focusing narrowly on the next quarter or, at best, year. I think Fink's tax proposal is sensible and should be adopted-- hopefully the Chamber of Commerce and similar groups push for something like that.

Will post more thoughts-- but what do you all think?

[Simfan34]

BlackRock CEO Laurence Fink, who would likely be Hillary's Treasury Secretary, has been fairly good on position favoring regulation of his own industry. He also has a pretty populist idea of capital gains tax reform based on length of investment--so day traders would pay really high rates while those who hold onto the investments for 3, 5, or 10 years would pay less, which would favor smaller investors and retirement funds over Wolf of Wall Street types and stabilize the market to prevent recession-starting short term bubble parties.

"Cracking down on Wall Street" is a crock, anyway. A good banking and investment sector is important to our national economic strength. The more important thing progressives should be focusing on is to make sure these rich people are paying a fair income tax and that our poorer citizens have access to affordable education to become recession proof via mobility. We wouldn't be better off if Wall Street were destroyed and everything else the same. There would just be different group of rich people starting gigantic financial bubbles.

King (as is often the case) is right, but I don't think calling for a more graduated and genuinely long-term oriented capital gains tax regime is "populist". Fink's proposal called for extending the "short-term" period to 3 years and applying progressively lower rates until 10 years, after which capital gains would not be taxed at all.

A genuinely more "populist" measure would be an FTT, which would penalise high-frequency traders, who, it is said, are engaging in nothing more than high-tech arbitrage that provides no benefit to the wider economy. For me, at least after reading Flash Boys, this seemed rather clear, in which case an FTT would be sensible policy (in effect being a sin tax). However, more recently, I've seen evidence suggesting that the traders' claims that HFTs add liquidity to markets is not entirely without substance, in which case you have to try to quantify and weigh whatever benefits--fiscal and economic-- an FTT would have against the costs of reduced liquidity in markets from reduced HFTs. I think someone (DC Al Fine?) was talking about this recently.

[Simfan34]

This has sort of become a pet issue of mine recently, and I made this post not long ago:

The key is to encourage long term focused corporate management, reducing incentives to eschew investment in favor of short term value maximization, and more direct pressures in the form of buybacks and dividends. Policy approaches to this end would involve restructuring the capital gains tax to favor real long term ownership (1 year is not long term) and corporate governance to favor more long term interests.

Underutilized capital could be mobilised by the National Infrastructure Bank we've long talked about, with its bonds carrying highly advantageous tax incentives. (A deduction on purchases and exemption on interest, perhaps). The point of the Bank would not be Keynesian stimulus but rather infrastructural investment to boost competitiveness. A national broadband network as in Australia, port expansion, railway electrification, high speed rail, smart grid, etc.

A few years ago people were talking quite a lot about the vastness of the cash reserves corporations were sitting on and not doing anything with. I don't know how much this has changed in recent years, but this idea started to seem like a good idea to me back then, so I don't know how much of a good idea it is now. This goes back to my ideas on a "tax code that encourages manufacturing and savings" that I meant to get back to Frodo about three years ago now but still never have.

Before hearing about Fink's ideas I read a number of articles in the HBR on this issue, which, if I can find them and if I have time this weekend, I'd like to look over again and comment on. One of the key takeaways was that stock-based compensation was amplifying short-termist pressures on executives, even at the expense of the long-term health of the company. Essentially, it was driving them to think like activist hedge fund managers, sharing their obsession with maximising shareholder (since they are shareholders!) value above all else. One solution I recall being suggested was to shift from stock-based compensation towards compensation based on alpha (the value added by management, calculated by comparing a company's stock performance to that of a market index-- roughly speaking, I'm not a finance person), essentially a novel form of performance pay.

There's evidence to suggest that this kind of activity is encouraged by low interest rates, so that might be one (extra) reason to support a rate rise.

[DC Al Fine]

A genuinely more "populist" measure would be an FTT, which would penalise high-frequency traders, who, it is said, are engaging in nothing more than high-tech arbitrage that provides no benefit to the wider economy. For me, at least after reading Flash Boys, this seemed rather clear, in which case an FTT would be sensible policy (in effect being a sin tax). However, more recently, I've seen evidence suggesting that the traders' claims that HFTs add liquidity to markets is not entirely without substance, in which case you have to try to quantify and weigh whatever benefits--fiscal and economic-- an FTT would have against the costs of reduced liquidity in markets from reduced HFTs. I think someone (DC Al Fine?) was talking about this recently.

Yes that was me. Leftists/populists tend to ignore the costs of illiquidity. High frequency traders have helped to drive down the bid-ask spread on securities. The bid ask spread is the difference between what you can purchase a security for and what you can sell it for.



A hefty financial transaction tax would weigh on even modest investors and drag their returns down, reducing the ability for employees and pension plans to invest for retirement.

[Taco Truck 🚚]

Yes that was me. Leftists/populists tend to ignore the costs of illiquidity. High frequency traders have helped to drive down the bid-ask spread on securities. The bid ask spread is the difference between what you can purchase a security for and what you can sell it for.



A hefty financial transaction tax would weigh on even modest investors and drag their returns down, reducing the ability for employees and pension plans to invest for retirement.

Lol!

Nice piece of propaganda.  Yeah sure high frequency trading is solely responsible for that graph.  You do realize during that time period stocks went from being quoted in fractions to being quoted in decimals.

Your inexperience is showing.  When that graph began most people called up an expensive broker to do a stock trade.  By the end of the graph most people were trading from their smartphone electronically.  Of course all fees were going to go down regardless of high frequency trading.  The trading of securities has undergone a massive change in the last two decades.  The fact you didn't know that says a lot.

And I don't even know what that graph is supposed to be showing.  Stocks aren't quoted in basis points.  Bonds are quote in basis points and most bond issues are so illiquid there is no way they could be traded via HFT.  A lot of bonds are still traded the old fashion way by a client calling a broker/dealer on the phone.

Read up on this stuff before slandering "leftists".

[DINGO Joe]

You're all too late, the new bogeyman is an old bogeyman Conglomerates

[Simfan34]

Dividends should be taxed as normal income in order to disincentivise their issuance and instead incentivise profit retention and reinvestment.

[TheDeadFlagBlues]

[Simfan34]

With a large-scale repeal of financial regulations looming, this thread is more relevant than ever.

Dividends should be taxed as normal income in order to disincentivise their issuance and instead incentivise profit retention and reinvestment.

I've grown conflicted about this. The point of increasing reinvestment rates stands, but I wonder if disincentivising dividends, would only serve to encourage only more interventions aimed at raising share prices in the short term in order to compensate for the lost shareholder gains.

The issue, I suppose, is that these are meant to serve two different purposes in the service of boosting "long-termism". Reducing dividends encourages management to reinvest profits,  while a regular dividend might encourage investors to hold on to stock longer rather than seek the short term maximisation of "shareholder value", and thus reverse the trend of decline in the mean stock holding period.

[parochial boy]

Rather than clamp down on Dividends, I would suggest clamping down heaily on share buybacks.

For companies, its a great way to increase their share price artifically, and of course, it uses up a boat load of cash that would have otherwise been used for investment.

Not sure how you would regulate it though, but it is one of the worst forms of corporate short termism.

[Torie]

Assuming the market is reasonably efficient, and the premise is that corporations should be into profit maximization, then short term profit boosting at the expense of a longer term sub par performance, would not happen very much. The market would punish the corporation, and it would be a takeover candidate. But yeah, it happens, because stock options, and what not, along with "creative" accounting, tend to reward some executives for playing for short term gain. The fix is probably to dig down deep into how CPA's operate, and disclose, for public corporations.

[muon2]

I have often wondered how much of short-term-ism stems from quarterly reporting compared to annual reporting. The market builds in expectations of the performance of a company to the price. The report gives the market a chance to see if the expectations were met. In order to meet shareholder expectations there is pressure on the company to perform on a time-scale comparable to the reporting period. That would lead to short-term profit maximization. A longer period between reports could reset the scale for corporate decisions. Of course fewer reports reduces transparency and information to the market, so one has to ask what would serve the economy best.