The Problem with Short Termism
The Kay Review is an excellent initiative and one we wholeheartedly welcome in terms of its analysis of the problem. The clear conclusion is that there is a problem with short termism in the UK equity market, and that this is detrimental to companies, evidenced by falling business investment, and to investors. The Review also finds that systemic problems with the culture and functioning of the equity market are at the root of the problem. So far so good, and supportive too of things that we have been writing about on this blog and elsewhere for many years. But my concern is that the scale and robustness of the recommendations fall far short given the magnitude of change required, and the entrenched nature of the vested interests that will try to prevent it.
One particular aspect of short-termism that Kay eloquently describes is the bias towards action at every point in the investment chain. I’ve always thought of it rather too simplistically as people wanting to look busy in order to justify their role (and salary/bonus). Kay sums it up much better as “many people in the financial services industry who claim to be in the business of providing advice are in fact in the business of making sales.”
Restoring Trust and Building Confidence
The central theme of the review is the need to restore trust and build confidence. Kay points out that regulation tends to treat the symptoms and not the cause and what is needed instead is a fundamental change in culture. A culture that creates strong incentives for market participants to invest for the longer term and to engage in good stewardship. If Kay’s portrayal of 'alpha' as a zero sum game should lead asset owners to focus more of their energy on beta, then the incentive towards engagement to lift standards across the market will become stronger. However, whilst short termism remains in the ascendency, the efforts of the universal owner through high quality engagement suffers from a ‘tragedy of the commons’, so as one member of the audience pointed out, we need to find a way in which to ‘crowd in’ good behaviour and long-termism.
Unravelling this Gordian Knot is no mean task, and this is why the recommendations look unambitious when set against the excellent summation of the problem which forms the first part of the report. Expanding the scope of the Stewardship code sounds good, but too many managers approach this from a compliance perspective already. The idea of an investor forum for institutional investors does not clearly explain how and why this would be any more effective than the multiple structures that are already in place. Establishing a set of principles of good practise does sound like a more interesting initiative, but also risks falling into the category of the casually observed sign-off.
Driving Momentum
Sir John Rose (former CEO of Rolls Royce and review advisory board member) remarked that the report is “going with the grain of concern and is intended to be directional in nature.” If that is to be the case, then it is to be roundly welcomed, but what is now required is to drive the momentum from here. There have been good initiatives around this agenda before which have quickly run into the sand and had little impact. What is needed now is for a coalition of the willing that connects asset owners, investors and the companies that they invest in. Then we can start to create the irresistible momentum that will, finally, start to crowd-in more and more of the market.
I guess this needs to have media attention at Parliamentary level. I also feel this should be something UKSIF should be championing as part of their core strategy. It's only when culture starts to change long term will factors like ESG suddenly hit people between the eyes.
I guess it's up to all of us to start shouting.
By Richard Essex on Jul 31, 2012 at 09:37 AM
I think the article is spot on. The Kay report does an excellent job of diagnosing the problem but is short on solutions. But he has done a great service nonetheless. Perhaps it will take time for enough people to become convinced that there is a problem before real effort goes into finding answers. We have seen the same with lots of difficult issues, e.g income inequality, too big to fail banks, climate change, resource pressures etc. There has to be a cultural change and there is no quick fix.
Professor Kay rightly says the basic function of the equity markets is to serve businesses that seek capital and savers who seek returns and that the financial sector should be seen as an intermediary to meet these needs.
But in the UK the financial sector is also one of our biggest businesses in its own right, providing well-paid jobs and domestic and overseas earnings. So making the changes required to make the equity markets work means deliberately dismantling one of our most successful industries. Isn't that at root why radical change in the direction the report suggests is unlikely to appeal to politicians, or the commercial lobbyists who influence them to protect the status quo?
By Susan Seymour on Jul 31, 2012 at 11:23 AM