A sure way to grab a headline and 15 minutes of fame (paraphrasing Andy Warhol’s immortal quip) is to blame investors and/or corporate managers of being myopic, that is―short-term oriented. Despite the fact that there is absolutely no evidence that neither investors nor managers are, in the main, short-term oriented, such claims are often made and, surprisingly, still draw attention.
A case in point: The Wall Street Journal reports today (January 24, 2019) that Michael Sabia, who runs a large Canadian pension fund, took the stage at the Davos annual fest of grandees to express the fear that “…finance has forgotten its original purpose as backers of corporate investment. Instead, financiers have become mere tourists who care little about the companies they own…. Instead of stepping up and encouraging the companies they own to invest in order to enhance productivity and long-term returns, they have completely lost sight of what the financial markets are about.” (Emphasis mine). The evidence advanced by Mr. Sabia to back his claim? Apparently none.
So, here is the evidence, which flatly rejects the oft-heard claims about investors’ and/or managers’ myopia. The figure below, from economists Carol Corrado and Charles Hulten, portrays U.S. corporate investment in tangible (property, plant, equipment, structures) and intangible (R&D, patents, brands, IT, human resources, artistic designs) assets, relative to gross value added. The figure clearly shows the dramatic transformation of the U.S. economy over the past four decades from relying primarily on tangible assets (an industrial economy) to being primarily based on intangibles―the upward-sloping curve. Looking at the intangible investment curve, an investment which surpassed $2 Trillion (yes, trillion) in 2017, do you see anything to back up Mr. Sabia’s claim that investors need to increase their support of corporate investment in long-term projects? Practically all investments in intangibles (R&D, brands, IT) are long-term investments, and investors seem happy to keep investing in intangibles-intensive companies. Truly myopic investors wouldn’t have tolerated such massive corporate investment and would have dumped the shares of the investing companies. Why do investors encourage companies to invest in the long-term? Because these are value-enhancing investments, as evidenced by the fact that corporate earnings have kept rising since the financial crisis.
True, not all companies invest in the long-term, and not all should invest. Only enterprises with attractive investment opportunities, in products and services development, customer growth, or artistic designs should invest. Absent such investment opportunities, companies should distribute their excess cash to shareholders.
And here is an interesting finding from my current research with Anup Srivastava on value investing. A finding which directly contradicts the claims of investors’ short-termism. The figure below portrays the average annual R&D spending―a major long-term investment―relative to total expenses, of four groups of public companies classified by investor’s valuations of their shares. On the right of the figure are the 30% of U.S. public companies with the highest investor valuations (measured by the share price to balance sheet book, or equity value), classified into large (top figure on right) and small (bottom figure) companies by market capitalization. On the left of the figure are the 30% public companies with the lowest investor valuation.
The difference in R&D investment of these companies couldn’t be starker: The high valuation companies on the right invest heavily in R&D, year in and year out. In recent years they have invested 10-20% of total expenses in R&D. In particular, note the continuous increase in R&D investment of the smaller, younger companies (bottom right figure). In contrast, the low-valuation companies on the left, big and small, hardly invest in R&D, or in innovation, in general. No good investment opportunities.
And here is my punchline. In contrast with Michael Sabia who claimed that “… finance has forgotten its original purpose as backers of corporate investment.” investors indeed strongly back companies which invest in the long-term by paying dearly for their shares. Remember, the companies on the right of the figure, with heavy investment in R&D, are the highest valued (priciest share prices) in the market. So, where is shareholders’ reluctance to buy shares, or back long-term investors? It simply doesn’t exist. Investors’ and managers’ short-termism is a myth.
If I were important enough to be invited to Davos (a politician, CEO, pundit or financier) I would have set the record straight on the absurdity of the sort-termism claim, once and for all. Unfortunately, I am just an academic and I was therefore left to stay in New York. Hopefully, however, this blog post will, through you, travel to Davos.