Somewhere in all the economic growth, we have forgotten that long-term sustainability (however you define it) usually comes at short-term cost.
But for a world of instant-gratifiers… That’s not so easy.
Here are some graphs showing how long we tend to own a particular share:
Traditionally, the long-term holders of shares are the big pension funds slash institutional investors – who aren’t concerned about the short-term movements in the market; but are taking a position for long-term outlooks to match their long-term liabilities.
What we should be noticing is how we are progressively holding shares in a company for shorter and shorter periods of time. And, concerningly, the last time that shares were held for such short periods in America (the NYSE) was just before the great crash of 1929…
There are some potential conclusions to draw from those graphs:
- The big institutional investors are now being completely out-traded by the speed with which small speculators and hedge funds are turning over their stock-holdings;
- There’s a formula error where short-selling is counted as a negative holding period (always possible);
- The asset managers of the big institutional investors have “augmented” their trading strategies in order to try make short-term gains and thereby earn better performance fees this quarter;
- Big institutional investors can lower costs by trading in derivatives linked to shares, rather than the shares themselves (I can’t believe this is true though); or
- Some other obvious-after-the-fact explanation that I haven’t thought of.
But regardless of the reason for the short-term trading bias (my personal votes are with 1 through 3), there is a managerial incentive implication that we should all be paying attention to.
If we go back a second and bring Jack Welch AKA Mr General Electric into the picture, the West has spend the last 30/40 years building its investment and directional philosophy around the concept of Shareholder Value Maximisation*.
Shareholder Value Maximisation: the objective of managers and directors should be to maximize the value (ie. share price) for the holders of the company’s shares.
Which seems to be a fairly good idea, right? The owners of the company will surely have the greatest interest in seeing the company grow and do well. And the business world then turned its attention to “aligning the interests of management with those of the shareholder” by granting management share options and performance-linked bonus incentive schemes and so on.
A question: what happens when the owner of the business is only interested in having his value maximized over the next 7 months? Because that’s what the above graphs are saying. That the owners expect to extract their maximized value within a year of buying their ownership share, now that they have the flexibility to take their investment elsewhere by selling their shares this afternoon.
Do you think that such owners are interested in long-term projects? Or in sustainable growth that might require some upfront capital investment, but will pay out great returns in three to four years time? And do you think that these owners are even interested in replacing capital equipment?
If we’re honest, I think that we’d answer all those questions with a collective negative. Because you’d be interested in quarterly earnings, and how those can be maximized by cutting costs and generating the greatest profit from the assets immediately disposable to that end.
It’s short-term. And destructive to the capital base of the company in question.
To the point where Jack Welch turned around and called his idea the worst in history… And to put that into perspective, it’s the business version of Buddha sitting down to a dinner of roast lamb.
*A Jack Welch initiative.