Malcolm S. Salter

How Short-Termism Invites Corruption…And What to Do About it

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 U.S. 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.

Short-Termism at Its Worst: How Short-Termism Invites Corruption… and What to Do About It

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 U.S. economy.I argue in this paper that short-termism also invites institutional corruption. Institutional corruption in the present context refers to institutionally supported behavior that, while not necessarily unlawful, erodes public trust and undermines a company’s legitimate processes, core values, and capacity to achieve espoused goals. Institutional corruption in business typically entails gaming society’s laws and regulations, tolerating conflicts of interest, and persistently violating accepted norms of fairness, among other things.Section 1 introduces the twin problems of short-termism and institutional corruption and shows how the latter has led to a diminution of public trust in many of our leading firms and industries. Section 2 presents an illuminating example — just one of many possibilities — of short-termism and institutional corruption, namely the gaming of Securities and Exchange Commission rules by Citigroup’s mortgage-banking desk in 2007. Section 3, building on the Citigroup example, identifies the principal types of gaming and demonstrates just how pervasive gaming of society’s rules has become in recent decades. Section 4 explains how short-termism invites gaming and other forms of institutional corruption, and draws attention to seven significant sources of short-termism including: shifting beliefs about the purposes and responsibilities of the modern corporation; the concomitant rise of a new financial culture; misapplied performance metrics; perverse incentives; our vulnerability to hard-wired behavioral biases; the decreasing tenure of institutional leaders; and the bounded knowledge of corporate directors, which prevents effective board oversight. Section 5 addresses what is to be done about short-termism and the institutional corruption it invites. Recommendations and suggested reforms relate to the improvement of board oversight; the adoption of compensation principles and practices that can help mitigate the destructive effects of inappropriate metrics, perverse incentives, and hard-wired preferences for immediate satisfactions; the termination of quarterly earnings guidance; and the elimination of the built-in, short-term bias embedded in our current capital gains tax regime.