McKinsey has a new study out on an important topic: whether corporations systematically take too short a view and do not invest enough for the long term. If true — as many chief executives believe — this is a serious indictment of current corporate governance arrangements and has important policy implications. To take one close to my heart, if short termism causes under investment, it will be a cause of secular stagnation.
I am not sure what to believe in this area. On the one hand, many anecdotes suggest that pressures to manage earnings hold back investment. And the short termism view is very widely believed.
On the other hand, some of what is done in the name of long term may be unmonitored waste. The observation that many “unicorn” companies with no profits, and sometimes no revenue or even fully developed products, get valued so highly makes me skeptical of the idea that the capital market is systematically myopic. It is also the case that the companies generating the highest immediate cash flows — which should be overvalued on the myopia theory — historically have had the highest stock market returns, implying undervaluation rather than overvaluation.
I was therefore excited to see that McKinsey had a new empirical study that provides evidence in favor of the view that corporations should take longer views. They have a reasonable methodology. They divide their sample between companies that take a long-term view and those that do not and then compare their performance. They find that companies that take a long-term view perform better on many metrics such as employment growth and shareholder return.
Their findings deserve much discussion, debate and attempts at replication. At this point, though, I would give a Scottish verdict of “not proven” to their case. They may be right, but I do not think they have provided evidence that would convince anyone other than a prior believer.
Consider an analogy. It is doubtless the case that golfers with long swings such as Phil Mickelson hit the ball farther and more accurately than golfers with short swings like myself. An index of swing length would be highly correlated with almost any measure of golf performance. Does this mean I should lengthen my swing? I doubt it. Those with more flexibility and coordination are able to take and control longer swings and play golf better. If I were to try to swing like Mickelson, I would mishit the ball and maybe break my back.
Some companies have great ideas, great management teams and compelling strategies. They invest heavily, seek to grow revenue, ignore the management of earnings and do limited stock buybacks. These are the criteria McKinsey uses to measure long termism. Others lack vision and have mediocre management. They invest less, cut costs more, manage earnings and buy back stock. McKinsey deems them short-term focused.
It's no surprise that the long-term companies outperform the short-term companies. But this may be because of their vision and execution capacity, not their long-term focus. Mediocre companies seeking to imitate them will be like me trying to imitate Mickelson — painful failures. I do not see any basis in the McKinsey results for saying that companies should extend their horizons.
McKinsey tries to address this issue by doing comparisons within industries. But everything we know suggests that there are substantial differences in company quality within industries as well as across industries.
Again, it may be that the long-termism hypothesis is right, and there may be ways of teasing causality out of the very interesting data set that McKinsey has created. But at this point, I think the issue is still unresolved.
Lawrence H. Summers, the Charles W. Eliot university professor at Harvard, is a former Treasury secretary and director of the National Economic Council in the White House. He writes occasional posts on Wonkblog about national and international economics and policymaking.