Corporate short-termism–where companies sacrifice long—term value for transient boosts in short-term stock prices—has long been a hot topic of debate in corporate law and political discourse. Critics argue that activist hedge funds, performance-based compensation, and quarterly reporting have forced public companies to sacrifice long-term profitability to hit short term metrics. In a new paper, however, I argue that private businesses also suffer from a plague of short-termism
Publicly traded firms are not, of course the exclusive or even the most common form of business association. Partnerships, LLCs, nonprofits, cooperatives, and mutual companies collectively account for most American economic activity and dominate industries like hospitals, higher education, charities, agricultural production, electricity transmission and distribution, and insurance and banking services. They suffer from short-termism in the same ways that public firms do. Focusing on them, however, also reveals the under-studied, but potentially equally destructive, impact of short-termism’s mirror image: long-termism, where companies sacrifice overall company value for long-term destructive goals.
Take, for instance, private investor-owned firms. They can be very large, like Cargill and its $175 billion of annual revenue, or much smaller, like the everyday firms that account for most job creation, but they all share the feature of having shares that do not trade on public exchanges. These shares are still bought and sold, however. Even the smallest firms must redeem shares when owners are incapacitated or ready to leave the business, even if transfer is otherwise restricted.
Since they lack a public exchange, private company shares need an alternative valuation mechanism, and private firms often adopt formulas based on recent performance (sales, earnings, or profits), a multiple of book value, or simply a fixed price written into company documents. Yet these mechanisms typically do not track long-term value, and they invite manipulation by owners. Valuations set by recent sales, earnings, or profits can all be boosted by cutting prices to pull forward future sales, booking future sales on unfavorable discounted terms today. Book value or a fixed share price omits future research and development potential and other intangible assets. The result: sacrificing long-term value for transient share-price bumps that can embroil these firms in litigation.
Other types of entities suffer from short-termism, too. Agricultural cooperatives value owners’ interests based on a pro-rata share of historical profitability, ignoring the value of future projects, which gives owners an incentive to veto even profitable projects. Mutual insurance companies, credit unions, and mutual banks are hamstrung by state provisions that force distributions of accumulated earnings—sometimes accrued over centuries—solely to current members, placing pressure on these firms to convert to publicly traded investor-owned firms even if the conversion will destroy company value. Even nonprofits are not immune: Universities often chase rankings metrics at the expense of institutional competence.
Focusing on private businesses also highlights the risks of long-termism, with firms pursuing long-term goals at the expense of enterprise value. The phenomenon has been identified anecdotally among public firms, but a dearth of examples has made it difficult to develop a systematic theory.
These businesses, especially nonprofits, present a rich field of study. Laws barring distribution of profits can leave nonprofits poorly monitored and give their managers excessive latitude in running the firm. Even when nonprofits are adequately monitored, they often operate in markets like healthcare, education, and charity work where it is difficult to assess quality and judge whether management is doing a good job. Consequently, many nonprofits amass enough capital to ensure their long-term stability—one of the few objective measures of “success”—even when they are no longer successful in a meaningful sense. Hospitals that serve shrinking populations are an example of this phenomenon.
This view of other enterprises can seem troubling. Fortunately, there are private and statutory solutions. As to the short-termism problem, a share-valuation mechanism that took into account multiple pre-identified formulas would discourage firms from gaming a particular measure to maximize short-term share prices at the expense of overall value. As to long-termism problems, relaxing nonprofit distribution prohibitions could encourage more effective stakeholder engagement, and regulatory tax policies could deter excessive capital accumulation.
Studying other businesses also has useful implications for publicly traded firms. For instance, an appreciation of how short-termism plays out in these contexts provides new insights about dual-class shares, which present both short-termism and long-termism worries. It also sheds light on the understudied phenomenon of long-termism. Finally, it gives a useful sense of the relative scale of short-termism problems: Continued efforts might bring marginal improvements among publicly traded firms, but other enterprises are fertile ground for major gains.
Peter Molk is the John H. and Mary Lou Dasburg Professor of Law and senior associate dean for faculty affairs at the University of Florida’s Levin College of Law. This post is based on his recent paper, “Short-Termism (and Long-Termism) across Enterprise,” available here.