Mandated quarterly earnings reporting and activist investor pressure have created a short-term orientation in public markets that is detrimental to long-term value creation.
The world’s largest asset manager, BlackRock, recognizes this bias toward the short term. In a letter to CEOs in 2015, Laurence Fink warned that “the effects of the short-termist phenomenon are troubling … more and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
These words have been borne out by research. For example, a survey of 401 financial executives found that 78% would sacrifice long-term value to smooth earnings. Other researchers point to corporate dividends and buybacks as evidence of the short-term orientation of public markets. Public companies have paid out a stunning 90% of their profits in dividends and share repurchases, leaving little available for investment in the long term.
While it’s difficult to quantify this bias’s economic impact, Singapore’s research provides some insights. In 2003, the country implemented a listing rule that required firms with a market capitalization above S$75 million to publish quarterly financial statements. A study found that this hurt small firms, with a 5% decrease in firm value.
Private versus public disclosure requirements
Decades of legislation have created a burdensome disclosure regime for public companies. Once public, firms must disclose an ever-increasing amount of information to satisfy the demands of regulators, investors, and the general public.
This disclosure imposes costs in terms of time and money and can impede a firm’s ability to compete by revealing information that would be a better-kept secret. In addition, the quarterly earnings reporting process creates pressures that can lead management to make suboptimal decisions to meet short-term targets.
In contrast, private companies are not subject to these exact disclosure requirements. They can choose to disclose information voluntarily and are not under the same pressure to meet short-term targets set by analysts and investors. As a result, private companies can take a longer-term view, making decisions that are in the business’s best interests without having to worry about the short-term fluctuations of the stock market.
When it comes to deploying capital, private companies have an advantage over public companies. They can choose to reinvest profits in the business rather than allocating them to dividends or share repurchases. They can also make longer-term investments, such as in R&D or new products, without worrying about the short-term impact on earnings.
Private market investors enjoy persistently higher returns
The evidence is clear that private market investors enjoy persistently higher returns than public market investors. The degree of causality is still being debated. Still, intuitively it makes sense that a longer-term orientation and the ability to deploy capital without the shackles of quarterly earnings reporting would lead to superior returns.
Other factors, such as inefficiencies in the private market and the lack of liquidity, also play a role. Research suggests, for instance, that the liquidity discount premium can be as high as 65%, with more conservative estimates in the range of 20-30%.
The resulting outperformance of private markets has led institutional investors to allocate an ever-increasing amount of capital to private equity, venture capital, and other private market strategies.
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