Stock Market Short-Termism: What the Empirical Evidence Tells Policymakers

In this paper and the related book section, I assess what the evidence on stock-market-induced short-termism tells us for policymaking. For this kind of policymaking purposes, we want to know whether the stock market is inducing economy-wide costs, and what the cheapest remedy would be for those costs. In public discourse, stock-market-induced short-termism is thought to be significant economically and socially.

Although the non-academic views seem to approach consensus that stock market short-termism is a major problem, there is no consensus in the academic studies on the subject. With the studies so divided, it’s hard to be sure that there’s a serious problem that should be prioritized over other economic problems the country faces.

Second, when we examine the mixed and divided evidence, we see that the evidence for short-termism tends to indicate that the short-termism involved is small. That is, strong studies find short-termism, but they generally find the inefficiencies to be small.

Third—and a contribution of the material that is not well-developed in the academic literature—the methodological setup needed for most successful empirical studies aims to reveal a local effect in a local treatment group. That method does not show that there is an economy-wide impact, and generally does not seek to show that it is. For the most part, the direct evidence that we want—is the economy suffering overall?—is not available. Most of the rigorous studies cannot readily scale to make an economy-wide finding.

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Let’s go over these findings in a little more detail.

I first look and assess at the evidence for and against stock market short-termism being an important economic problem and set out the best evidentiary case for each view. The core reason for the review is to assess whether the most prominent findings tell us whether we have a costly economy-wide problem. The most prominent findings are divided.

In the next section of the paper, I evaluate this evidence. Many studies do not find stock market short-termism where one would expect to find it. If short-termism were deep, wide, and costly, more of the studies should find it in play. Several of the iconic and most convincing studies for stock market short-termism being a problem, the paper’s analysis shows, point to it being a small problem and not the major economic shortfall that needs policymakers’ attention.

In addition, different mechanisms have different results in the short-termism academic work; i.e., activism is found to induce short-termism less often than quarterly reporting.

The paper next considers partial equilibrium thinking and how it applies to the academic work in the area. The partial equilibrium concept is basic to economics generally but typically absent from corporate governance analytics. Even a negative “local” finding (i.e., that stock market short-termism damages targeted firms) must be assessed for policymaking purposes for its economy-wide impact. And that impact might be negative economy-wide or it might not be. If the local negative result in a treatment group indicates how the entire economy behaves, we have an economic problem. But if the local effects are offset elsewhere, because they give profit-making opportunities to others in the economy, then the question for policymaking purposes is how effective and efficient the offsets are. If the offsets have some costs but are almost as good as what is lost in the treatment firms, then the offsets would make the economy-wide problem a modest one. Offsets may be common, or they may be absent. But a full policy analysis should be aware of the extent of the offsets.

A little more on this, to see the research problem. The major studies do not assess the economy-wide problem directly, and neither do less-well-known studies. If short-termism disables important competitors in a way that allows an entire market to slack off—or if it disables an entire industry—then we have a system-wide problem from short-termism. Then the question for policymakers is a basic cost-benefit analysis of policymaking action. But in a competitive, decentralized economy, the question is not whether some firms fall short. Rather the question is whether enough competitors—other public firms, or other sectors or new entrants—pick up the slack often enough in a cost-effective way. If they do, we do not have a system-wide economic problem warranting significant policy attention.

To underscore this aspect, I show how related business law areas, like antitrust, ask the right questions here, both in academic work and in on-the-ground policymaking. Even if there’s a detrimental local effect, is the systemic effect severe, or are there enough offsets? I then show why asking such questions ought to be brought into corporate law thinking here for sound policymaking.

Other corporate law policy issues may be subject to the same partial equilibrium limitation.

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Thus, the overall analysis here for policymakers is that (1) the studies are divided, with no strong consensus, (2) the iconic evidence for short-termism being a major problem is less compelling than the public consensus view has it, in that the strongest studies finding it to be a problem are showing it to be a small problem, and (3) there’s a gap between finding “local” short-termism and knowing that there’s economy-wide short-termism; we need to know whether a formidable competitor is being disabled, inducing industry-wide slack, or whether a disabled competitor opens up investment and competitive opportunities for the rest of an industry and whether enough of those opportunities are taken and taken efficiently enough. Antitrust theory and practice deals with this analysis; corporate governance thinking generally does not.

The complete paper is available for download here.