Are You A Share Holder Or A Share Flipper?

By Ryan C. Fuhrmann | September 10, 2009 AAA

On Wednesday, leadership and corporate development non-profit organization the Aspen Institute issued a bold statement to speak out against short-term thinking. It also released a nine page document explaining why it believes that "short-term objectives have eroded faith in corporations" and the foundations of the American economy. The report carries weight for its message, recommendations and the handful of legendary figures that officially signed off on the call to action for investors and corporate managers.

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The Downside of Short-termism
The report singled out intermediaries including money managers, mutual funds and hedge funds that provide corporations with capital and are overly focused on "short-term stock price performance, and/or favor high-leverage and high-risk corporate strategies designed to produce high short-term returns." This leads to short-term behavior from corporate management.

It cited three primary problems to this approach. First, it is harmful to investor portfolios as it increases trading commissions and can lead to short-term capital gains, both of which eat into gains and overall portfolio capital. The next two concerns speak to the fact that short-term goals fly in the face of long-term value creation and can encourage taking on excessive risk and maximizing near-term profitability that can sacrifice growth over the long haul and sustainable earnings and cash flow generation.

How to Solve Short-termism
Aspen Institute sees three primary solutions to overcome the destructive nature of short-term investment views. The first concerns market incentives to "encourage more patient capital." Remedies in this category include lowering capital gains taxes the longer a security is held or eliminating the restriction that only $3,000 in investment losses per year can be deducted from ordinary income in personal tax returns.

To "better align interests of financial intermediaries and their investors", the Institute recommends changing incentives in 401(k) and ERISA regulations to support investment vehicles that focus on long-term value creation. This could be as simple as including restrictions on the extent to which investment managers are allowed to turn over their portfolios. This keys in on the third recommendation, which is to increase disclosures and eliminate the ability for short-term investors to gain influence over corporations.

For example, the report cited as an example "an activist who becomes a formal shareholder with voting power while simultaneously 'shorting' a corporation's shares or entering into a derivatives contract to hedge away its economic interest."

The Bottom Line
The report was signed off on by investing and corporate legends Warren Buffett of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), Vanguard Group founder John Bogle, former IBM (NYSE:IBM) CEO Louis Gerstner and John C. Whitehead, a former chairman of Goldman Sachs (NYSE:GS). These companies, along with Coca Cola (NYSE:KO) and Google (Nasdaq:GOOG), already stand out by being part of a select group that does not provide short-term quarterly earnings guidance.

Jim Collins spoke to the differences in short-term share price maximization and long-term shareholder value creation in his most recent business book, How the Mighty Fall. In it he explained that leaders who build great companies are able to focus on creating share value instead of share prices.

These leaders also differentiate between "shareholders and shareflippers" and seek out investors that understand that it is important "not [to] succumb to growth that undermines long-term value". (For more on long term investing, see our article 10 Tips For The Successful Long-Term Investor.)

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