Hillary Clinton’s big economic idea—ending corporate “short-termism,” as she calls it—will do more harm than good. On the campaign trail she rails against American corporations and the mysterious “tyranny of today’s earnings report.” Her solution is to raise capital-gains taxes and lengthen stockholding periods. Imagine anxiously waiting to unload during this month’s global selloff because of a holding period. Chalk it up as another misguided effort that will distort the information investors and companies rely on to make good decisions.
Markets run on signals. What could have been a housing downturn melted into the 2008 financial crisis in part due to lack of trading of mortgage derivatives in 2006-07. The prices didn’t reflect underlying value; it’s buying and selling of shares in the stock market that provides signals, to investors and to management, about the value of enterprises. Anything that mucks up those signals will be disastrous for decision making and the productive fabric of the economy.
Less trading means less information. Russia’s old stock exchange shut down amid the revolution in 1917 and eventually became a naval museum. Soviet planners embarked on five-year plan after five-year plan with no price signals. That experiment eventually failed. The Chinese are about to unveil their 13th Five-Year Plan. None of the previous plans highlighted Alibaba and the importance of online commerce. That’s because progress happens by surprise, not government planning. Investors need report cards to judge progress, and thus there’s quarterly disclosure.
But whether an investor is trading or putting a stock certificate in a safe-deposit box, stock markets facilitate access to capital. Part of that process is moving stock into the hands of those who desire a certain risk profile. Some, such as pension funds and Warren Buffett, like the steady cash flow of consumer and industrial giants. Others prefer lily pad investing, jumping from one hot idea to the next. Which is better for the economy? Neither. Both are important and healthy.
Despite harassment by shareholder activists, Apple increased research and development spending 40% this year over 2014, to almost $2 billion a quarter. Now that’s long-term investing. If activist investor Carl Icahn couldn’t change Apple CEO Tim Cook’s mind, why would higher capital gains taxes? On the other hand, paid television stocks are suffering this summer for not investing for a digital future. This is starting to show up in missed earnings. Maybe they’d like a decade or so to work things out without reporting earnings? Instead the market punishes them and reallocates capital to companies doing things right— Netflix and Facebook, for instance.
Sure, there are examples of rigging of quarterly earnings. Former Sunbeam CEO Al Dunlap produced great short-term earnings in the mid-1990s, but he eventually ran the company into the ground. Some investors will always be fooled by the glitter of good short-term results. But the folks at Fidelity managing mutual funds or hedge-fund manages operate on a longer time horizon. Their magic is that they can change their minds faster than everyone else when the signals disprove what they assumed.
Today there are two markets: those transforming the economy and those being transformed. The former—Amazon and Google, along with private companies such as Lyft, Pinterest and Airbnb—are afforded high valuations and almost unlimited capital to execute their business models. They are allowed to think long term. And those being transformed, from retailers to telecom, energy and media are used to thinking long term, but now must slash costs or face shareholder wrath. These are the companies doing share buybacks rather than building more stores or cable channels. Short-term thinking is required.
In short, Mrs. Clinton would like to make the already tough task of managing a company much harder. Getting the right mix of long-term investment and decent near-term results is a herculean task. Add to that the hassles about executive pay, accumulating offshore profits, increasing health-care costs and rising interest rates—and managing a company seems near-impossible. An accurate stock price reflecting what the market thinks of your company, not tarnished by limited trading or other rules, is the least the government can do.
The Taxpayer Relief Act of 1997, passed by a Republican House and Senate and signed by a Democratic president, Bill Clinton, lowered capital gains rates to 20% and ushered in an era of innovative business models knocking out tired ones. That kind of reform would spur long-term corporate thinking. But Mrs. Clinton’s plan will simply penalize those being productive in the economy and hamstring innovation.