Overcoming Short-termism

The Aspen Institute has released a September 9, 2009 report, Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management. It is short and clear (6 pages) and comes at a very timely moment. Signed by a diverse group including Bogle, Buffet, Lipton, Lorsch, Millstein, Stout, Trumka and Wilcox, the recommendations attempt to address three basic problems:

1. High rates of portfolio turnover harm ultimate investors’ returns, since the costs associated with frequent trading can significantly erode gains.
2. Fund managers with a primary focus on short-term trading gains have little reason to care about long-term corporate performance or externalities, and so are unlikely to exercise a positive role in promoting corporate policies, including appropriate proxy voting and corporate governance policies, that are beneficial and sustainable in the long-term. High-risk strategies designed exclusively to produce high returns in the short-run leads to market failures, social and environmental degradation.
3. If managers and boards pursue strategies to satisfy ahort-term investors, theyt can put the interests of sharewners seeking long-term growth and sustainable earnings and the corporation’s future at risk.

Institutional investors and related intermediaries should be properly incentivized to focus on the interest of promoting sustainable, long-term growth. The group divides its recommendations into 3 categories.

1. Market incentives to encourage patient capital are likely to be the most effective mechanism to encourage long-term focus by investors. To that end, the following are recommended:
   • Revise capital gains tax provisions or implement an excise tax in ways that are designed to discourage excessive share trading and encourage longer-term share ownership. Capital gains tax rates might be set on a descending scale based on the number of years a security is held. An excise tax could be imposed that would also allow for the inclusion of tax- exempt and other investment entities.
   • Remove limitations on capital loss deductibility for very long-term holdings, now capped at $3,000 per year for losses related to holdings of any duration.
   • In exchange for enhancing shareholder participation rights, consider adopting minimum holding periods or time-based vesting, along the lines of the one-year holding period required under the SEC proxy access proposal currently under review.
2. Better align the interests of financial intermediaries and investors by ensuring that the fiduciary duties of financial intermediaries are clarified, enhanced and rigorously enforced.
   • Apply a higher degree of accountability and enhanced fiduciary duties to financial intermediaries, by requiring increased disclosures on compensation, incentives, trading, policies on proxy voting and other matters that indicate compatibility (or lack thereof) with the fund’s stated objectives, and the goals of the ultimate beneficiaries.
   • Modify ERISA allowable investment practices through rule changes to promote long-term investing by those investors holding equity in tax-advantaged accounts.
   • Ensure, through clearer and more rigorously enforced fiduciary duties, that investment advisers of all types take into account, and clearly inform investors of, tax and other implications of changes made to encourage long-term holding as recommended herein.
   • Pursue regulation or policy to base the compensation of long-term oriented fund managers on the fund’s long-term performance and extend to such funds the compensation disclosure requirements that are currently applicable to operating companies.
3. The final leverage point, greater transparency in investor disclosures, especially of complex non-traditional structured and derivative arrangements, can also play an important role in helping corporations maintain a long-term orientation.

The maturation of the institutional investor community creates both opportunity and responsibility to promote the long-term health of capital markets and, in particular, to pursue investment policies and public policies that empower and encourage business managers and boards of directors to focus on sustainable value creation rather than evanescent short-term objectives.