Short-termism hasn’t hurt companies long term
AKIO MORITA, the legendary founder of Japanese electronics giant Sony Corp., once declared that “America looks 10 minutes ahead; Japan looks 10 years.” In an influential 1991 book called The Japan That Can Say No, Morita and his co-author, conservative politician Shintaro Ishihara, alleged that the short-term thinking of US companies would be their downfall. Constrained by shareholders more obsessed with next quarter’s profits than next decade’s market share, American leading businesses would inevitably lose market share to their more far-sighted Japanese rivals.
In retrospect, Morita’s assertion seems spectacularly ill-timed.
Remember the MiniDisc? In 1992, Sony created a better, smaller version of the compact disc. But a few years later, the MP3 turned the music industry on its head, making MiniDiscs instantly obsolete. In the end, Sony sold only 50,000 players, while Apple dominated the MP3 player market with the iPod and iPhone. Today, Apple’s market capitalization is about 17 times as large as Sony’s, and its revenue is about three times as large.
Which just goes to show: When you’re gazing off at the 10-year horizon, you should be careful not to stumble into a ditch in the next 10 minutes.
Morita’s critique of American short-termism is hardly uncommon. Andrew Grove, one of the founders of Intel Corp., used to make a similar argument, as have many others. Management guru Eric Ries has even looked into creating a new kind of stock exchange that would address the problem by forcing investors to hold stocks for longer periods of time.
But a new paper from Steven Kaplan at the University of Chicago’s Booth School of Business challenges this conventional wisdom. Kaplan marshals evidence from a variety of sources to argue that American companies are not too focused on the short term.
Kaplan’s first piece of evidence is the persistence of corporate profits. If US companies really became too focused on the short term in the 1980s, he argues, we would have seen an eventual collapse in their profitability. Instead, the opposite happened.
Kaplan’s second argument comes from the small size and modest returns of the venture-capital industry. VC represents a tiny amount of US assets -- usually about 0.1% or 0.2%. And except for in the roaring 1990s, VC returns averaged across funds have been fairly underwhelming. Limited investment combined with mediocre returns, Kaplan argues, are reason to believe that the lack of long-term investment is warranted by a real lack of long-term investment opportunities, rather than an artifact of investor short-sightedness.
Kaplan also argues that high stock-market valuations imply that investors believe US companies are poised for rapid growth. High price-to-earnings ratios can only be justified if corporate earnings grow rapidly; hence, Kaplan argues, if the market is at all rational, then US companies can be expected to expand, rather than shrink.
Finally, Kaplan points out specific instances where US investors have been willing to put up with low profits today in the expectation of high profits years or decades in the future -- for example, biotech stocks now, or Internet stocks in the 1990s.
These arguments are all reasons to be skeptical of the standard story of American corporate short-termism. But skepticism doesn’t mean dismissal; all of Kaplan’s points should be taken with a grain of salt.
For example, Kaplan’s point about the small amount of money allocated to venture capital seems to contradict his anecdotal examples of long-term bets. If US investors were really willing to bet big on the industries of tomorrow, like biotech or information technology, why is VC such a small fraction of a percent of the capital markets?
Kaplan’s demonstration of mediocre VC returns is more compelling, but even here there is cause for doubt. As Kaplan’s own research with Robert Harris and Tim Jenkinson has shown, VC tends to outperform the market on a capitalization-weighted basis -- in other words, big VC funds get most of the good returns. It’s worth asking why those big VC firms, with their expertise in picking winners, aren’t managing more of corporate America.
Kaplan’s point about high P/E ratios is also a bit suspect. As Kaplan notes, these could also be rising due to a reduced equity-risk premium -- in other words, people might be investing in US stocks because there are few other good alternative investment opportunities out there in the world.
Of all Kaplan’s arguments, the enduring profitability of US companies is the strongest. But here, too, there is cause for worry -- recent evidence shows that profits may have risen due to increased monopoly power, not long-term thinking.
Finally, Kaplan focuses on macro variables like P/E ratios, but ignores micro evidence on the short-termism question. For example, a 2014 paper by John Asker, Joan Farre-Mensa and Alexander Ljungqvist found that “compared to private firms, public firms invest substantially less and are less responsive to changes in investment opportunities.” Also, there’s evidence that founder-led companies tend to outperform.
So don’t count the short-termism hypothesis out just yet. Apple may have beaten Sony, but many US companies might still be hurt by the tyranny of quarterly earnings.