Representatives from FCLTGlobal were delighted to participate in the European Securities and Markets Authority’s (ESMA) workshop on short-termism, held in Paris on 16 September 2019. ESMA’s work on short-termism followed a Call for Advice issued by the European Commission to develop a report presenting the evidence and possible advice on potential undue short-term pressure on corporations.
The workshop was a series of structured segments based on research and evidence gathered by ESMA staff: investment strategy and investment horizon; disclosure of environmental, social and governance (ESG) factors and the contribution of such disclosure to long-term investment strategies; the role of fair value in better investment decision-making; institutional investors’ engagement; remuneration of fund managers and corporate executives; and use of credit default swaps (CDS) by investment funds. FCLTGlobal submitted a memorandum on evidence of short-termism in the capital markets, which we hope will prove useful to ESMA as it prepares a report for the European Commission late this year. Highlights include:
- Evidence from FCLTGlobal analysis. Based on our own analysis of large data sets, we found that long termism is in decline among corporations. When we look across all the measurable predictors of long-term success identified in our analysis, we find that global corporations have grown less long-term in recent years and remain substantially less long-term-oriented than they were before the financial crisis. One big reason is the rising tendency to distribute—and sometimes overdistribute—capital to shareholders. Another factor that weighs on long-term value creation is excessive leverage—though again this is not a blanket dismissal, as leverage can be vital to businesses. As a general tendency though, more leverage among companies in our dataset has translated into lower ROIC. Environmental, social, and governance (ESG) controversies can also be a drain on long-term ROIC, an effect that is most meaningful for larger firms with more extensive media coverage. And consistent with prior research, issuing short-term guidance also portends weaker performance.
- Evidence from FCLTGlobal Members. Our Members’ (McKinsey & Company and KPMG) analysis suggests that longer-term-oriented companies created significantly more jobs and generated significantly greater market capitalization, revenue, and earnings growth than shorter-term-oriented companies. While these studies highlight evidence of the benefits associated with long-termism, the inverse is also true: that short-termism is correlated with fewer jobs, lower market capitalization, revenue, and earnings growth. McKinsey survey data also suggests that taking a long-term view has a positive impact on corporate financial performance.
- Short-termism in public markets. Tackling short-termism in public markets has significant potential benefits. Short-term investors can encourage volatility and management turnover as they push for near-term shortcuts at the expense of long-term strategy. By contrast, a long-term investor base reduces a company’s cost of equity, in part due to the superior monitoring these investors provide and the strong match between their goals and the companies in which they invest. The presence of long-term investors also reduces stock price volatility, encourages greater fixed investment, and is even associated with higher returns.
- Short-term guidance versus long-term roadmaps. Although quarterly guidance is more of a U.S. phenomenon versus (only 0.7% of Euro Stoxx 300 companies issue quarterly guidance), it is important to recognize that this is not supportive of long-term value creation. FCLTGlobal analysis of the S&P 500 found that issuing annual range guidance reduces volatility around earnings reporting periods relative to issuing quarterly guidance, alleviating one potential source of short-term pressure (namely undue stock-price volatility). Just as short-term guidance is detrimental to long-term value creation, the inverse is also true: long-term roadmaps, a form of investor communication that includes a company’s 3+ year objectives alongside the strategic plan for achieving those objectives, tend to enhance long-term value creation
ESMA is an independent EU authority that contributes to safeguarding the stability of the European Union’s financial system by enhancing the protection of investors and promoting stable and orderly financial markets. It achieves this by assessing risks to investors, markets and financial stability, completing a single rulebook for EU financial markets, promoting supervisory convergence and directly supervising credit rating agencies and trade repositories.
To further substantiate its report on short-termism, ESMA shared responses to the questionnaire that issued in June 2019 to gather evidence on potential short-term pressures on corporations stemming from the financial sector. Based on its findings from the survey and the workshop, inter alia, ESMA will deliver a report to the European Commission that presents evidence and possibly advice on potential undue short-termism. The Commission will consider ways to follow up on the report’s findings, which may include policy actions.