Is short-termism wrecking the economy?

Bank of England chief economist Andy Haldane Image copyright AP
Image caption Bank of England chief economist Andy Haldane says he is concerned about short-termism

Last Friday on Newsnight the Bank of England's chief economist Andy Haldane sought to kick-start a debate on how companies run themselves.

He told me that companies risk "eating themselves" as shareholders and management were gripped by a form of short-termism.

Instead of investing in their futures firms are choosing to pay out too much of their cash to shareholders in the form of dividends or by buying back their own shares.

The Bank has now released the text of a speech Haldane made on his very topic some months ago which fleshes out the argument in more detail.

As with all Haldane speeches, it's both very readable and very interesting. Douglas Fraser has written up the details.

So, what's going on here?

As I said on Newsnight last Friday, it's now everyday that the Bank of England appears to question the workings of the core institution of contemporary capitalism - the public company accountable to its shareholders.

Assumptions

The preliminary question to any debate is: should the Bank even be talking about this?

That's a point picked up by former Bank staffer Tony Yates and answered by economist Simon Wren-Lewis.

For what it's worth, Wren-Lewis's longer answer - that the functioning of corporate governance matters for both economic growth and financial stability - is very similar to the longer answer Andy Haldane gave me last week which ended up on the cutting room floor.

Leaving aside the point about financial stability and whether the current model of governance encouraged excessive risk taking (which it might have), it's certainly worth considering whether "short-termism" may have serious economic consequences.

As Haldane has argued corporate investment has been weak for years.

It's not just an important reason why the current global recovery has been weaker than hoped, but a longer-running problem.

And it may be that it requires a "structural fix". The conventional levers of fiscal and monetary policy aren't getting the response one might expect.

Image copyright AP
Image caption US presidential contender Hillary Clinton has berated what she terms 'quarterly capitalism'

On the fiscal side, UK corporation tax has been slashed by the current government from 28% to a lowest in the G7, 20%.

And on the monetary side interest rates have been at a record low 0.5% for six years.

If lower taxes and low borrowing costs aren't spurring investment, then maybe it's worth trying something else?

This is the territory Hillary Clinton is on when she berates "quarterly capitalism" - territory long associated in the UK with the work of Will Hutton and the subject of a government review in the last Parliament.

One issue is whether such short-termism can really be bad for the whole economy rather than just individual companies?

If one short-termist company forgoes a profitable long-term investment, surely another (maybe privately-owned) will step in to make it?

Law reform?

Maybe. But I worry that makes some heroic assumptions about market structures.

In any industry with high barriers to entry, dominated by large listed firms, it may be that in the medium term the necessary investment can only come from the reluctant short-termists.

All of which makes this a debate worth having.

Of course, serial followers of the UK corporate governance scene may be left a little confused by this intervention, as in recent years much of the debate hasn't been focussed on over-mighty shareholders being too short-termist but on disinterested shareholders who don't take their ownership responsibilities seriously enough and have devolved too much control to company management.

But what sounds like a contradiction isn't necessarily so.

It's perfectly possible that shareholders might be too powerful and too disinterested.

The issue could be that management is too focussed on short-term shareholder returns and so prioritises returning cash to them and increasing the share price in the short term, even if that isn't in the company's long-term interest.

Image copyright AFP
Image caption In 1945 the average investor held a share for an average of six years, but that has now fallen to six months

To understand how this situation might have arisen over the last few decades, one only needs to look at two trends.

As Haldane argued last week - shareholding periods have fallen. There are fewer and fewer investors willing to take a long-term view.

And secondly the trend has been to increasingly tie top management payment to share price performance.

In other words, whatever the long-term benefits of investment in machinery, research or training five or six years down the line, we may have a system in which the rational thing to do is to focus on the next six months, not the next six years.

The possible fixes to this situation are many and varied - from embracing a Germanic system of stakeholder capitalism (in which the workforce as well as the owners have a role in decision making), to looking again at executive compensation or maybe to an intermediate situation - perhaps ordering directors to act in the interest of a theoretical "perpetual shareholder", rather than existing (often short-term) investors.

None of those options are a quick fix, all involve reform of the Companies Act, which is a mammoth bit of legislation.

And it's worth remembering that that act was supposed to allow a greater role for other stakeholders alongside shareholders but, in effect, it has increased shareholder primacy.

This is a big agenda and a big debate. On one level it could even be described as an attempt to save capitalism from capitalists, an argument that the ultimate owners of capital have stopped working in their own long-term interest.

But, perhaps in those terms, it sounds too radical. On a more micro level this is a debate about economic incentives.

It may simply be that the incentive structure in Anglo-Saxon capitalism has become skewed towards rewarding short-term behaviour.

If that is the case, then it's harmful to the economic growth but also very fixable.