07 Jun 2012  Working Papers

How Short-Termism Invites Corruption--And What to Do About It

Executive Summary — A long-term time horizon is most sensible where a business or investor has some edge and when short-term risks associated with a longer-term strategy are hedged and opportunity costs minimized. However, when perverse, short-term incentives artificially encourage executives to ignore high-yielding, long-term opportunities, then the costs of short-termism set in. The recent financial crisis suggests that the rise of short-termism has been especially troublesome in the finance industry. In this paper, Malcom Salter starts by analyzing a case involving the mortgage-banking desk at Citigroup because it can help us think about how short-termism-the collapsed time horizon of both business decision makers and investors-not only sabotages an enterprise's reputation and value, but also invites individual and institutional corruption. He then examines the key drivers of short-termism in contemporary business, and their potential effects on the behavior of both executives and their organizations. He concludes by proposing mechanisms to deter the corrupting effects of short-termism, including changes in both business and public policy. Key concepts include:

  • Today the seedbed for institutional corruption is richly endowed by perverse business and public policies that tend to limit the decision horizons of investment managers and corporate executives.
  • The absence of horizon-stretching management systems and public policies has tended to fertilize rather than discourage lawful but corrupt behavior-such as the purposeful and often institutionally supported gaming of society's rules.
  • The current wave of institutional corruption has inevitably led to diminished public trust in our leading business institutions, and persistent public calls for radical reform.
  • While business leaders and policymakers have been cautious in implementing countermeasures to the ill effects of short-termism, we must seriously consider them if we truly want to rein in the public and private costs of institutional corruption.

 

Author Abstract

Researchers and business leaders have long decried short-termism: the excessive focus of executives of publicly traded companies-along with fund managers and other investors-on short-term results. The central concern is that short-termism discourages long-term investments, threatening the performance of both individual firms and the US economy.

I argue that short-termism also invites institutional corruption. I define that as institutionally supported behavior that-while not necessarily unlawful-undermines a company's legitimate processes and core values, weakening its capacity to achieve espoused goals and eroding public trust. In the private sector, institutional corruption typically entails gaming society's laws and regulations, tolerating conflicts of interest, persistently violating accepted norms of fairness, and pursuing various forms of cronyism.

The gaming of Securities and Exchange Commission rules by Citigroup's mortgage-banking desk in 2007 is an illuminating example of institutional corruption in the finance industry. After exploring that case, I provide a more complete definition of gaming, and explain how short-termism invites the kind of gaming and institutional corruption that occurred at Citigroup. I then examine the key drivers of short-termism in contemporary business, and their potential effects on the behavior of both executives and their organizations.

I conclude by proposing mechanisms to deter the corrupting effects of short-termism, including changes in both business and public policy. While business leaders and policymakers have been cautious in implementing many of these countermeasures, we must seriously consider them if want to rein in the public and private costs of institutional corruption in the private sector.

Paper Information