Book Review: Saving Capitalism from Short-Termism

How to Build Long-Term Value and Take Back Our Financial Future

This is a great book. I got a lot out of the sections that bring to the surface a lot of the issues that we’ve been seeing in our economy.  These issues have been written about in countless places, but author Alfred Rappaport also proposes workable options that could be put into place to resolve these issues, a step that has been lacking in other places I’ve seen these issues discussed.

But I’m getting ahead of myself.  The issues I’ve referenced above are the sort of systemic issues we’re seeing in economy in general and specifically the financial services industry.  Included in these issues are the wild short-term fluctuations we have been seeing in the markets, in part due to the ways that CEOs are compensated, how investment managers are compensated, and how those compensation systems influence behaviors and methods of management.

Specifically, in today’s world CEO compensation is typically tied to earnings, on a quarter-over-quarter and year-over-year basis, which tends to cause the CEO to forego longer-term investments and moves in favor of moves that result in short-term earnings increases.  Once or twice this kind of activity might not cause much problem, but always opting for the short-term over long-term value creation has resulted in the kinds of wildly-fluctuating markets that we’ve seen in the past couple of decades.

Along the same lines, investment managers, specifically fund managers, tend to be compensated similarly with short-term views.  I’ve written about this in the past in an article explaining how many managed mutual funds wind up being closet index funds due to the nature of the compensation system, but I didn’t go into how managed funds could use a different method of compensation to resolve this.

These issues have been around for quite a while – oddly enough I recently found reference to the accounting shenanigans that are still in use today, in a book written in the early 1970’s, Super Money by Adam Smith.  Clearly the problem has been going on for a long time, and resolving it is going to take major changes.

Mr. Rappaport takes the situation a step further by providing real, workable examples of ways that the compensation systems could be re-aligned to provide long-term value from both the standpoint of the CEO and the investment manager.  The resolutions aren’t simple, and putting them into place will require buy-in from CEOs, corporate boards, and others stakeholders in the overall process.  Since the systems that we’re using have been in place for so long, it’s going to take guts from everyone involved – but the payoff should be enormous.

The payoff that Rappaport refers to is the creation of long-term value, which is in the best interest of all involved parties.  Just think of it!  An economy where we’re focused on longer-term values, rather than living and dying with each quarterly earnings report.  Massive fluctuations day-to-day fluctuations in the markets would be a thing of the past, and investing would become much less “exciting” – more like an actual saving activity than the crazy, topsy-turvy world we’ve had to get used to.

It’s a tall order to be certain, but the ideas that Mr. Rappaport has detailed are within reason and workable, but as I mentioned before they require buy-in from all stakeholders.  The ideas also require a sea-change in thought processes but as of now, they’re the only valid option that I’ve seen put forth.  I think anyone who is in a position to help put these ideas into play should read this book as soon as possible.

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not.  If you find the information in this review useful, let me (and McGraw-Hill) know!