Short-termism on stock markets
2018 Master Thesis
Faculty of Business and Economics International Financial Management
Supervisor: Dr. A. de Ridder
Co-assessor: Dr. W. Westerman
Burger, M. (Maarten)
Abstract
This paper addresses the question to what extent differences in the degree of short-termism on the stock market are present when comparisons are made based on the country of origin of a firm and based on its size. Data on twenty years, from 57 companies, from five countries is used. By using the Gordon-Shapiro Model to discount future dividend, it is found that firms from The Netherlands and the United States are more long term oriented than average, whereas firms from Great Britain, Germany and Belgium appear to be more short term oriented. Furthermore, it is found that medium-small firms and big firms are more long term oriented than average, whereas small and medium-big firms appear to be more short term oriented.
1. Introduction
Short-sightedness, also referred to as near-sightedness or myopia, is a common eye handicap from which approximately 25 percent of all inhabitants of the United States seem to suffer (Sperduto et al., 1983). Besides the medical field, this prevalence of myopia is also often referred to in, for example, the managerial (Stein, 1988), organisational (Levinthal & March, 1993) and economic field (Edmans, 2009). In these contexts myopia is used to refer to short-termism.
Jevons (1888), Marshall (1920) and Pigou (1932) show that there has been a long ongoing debate about whether or not this short-termism is also present on the stock markets. Miles (1993), and later Cuthbertson, Hayes and Nitzsche (1997) and Black and Fraser (2002), proved, by means of quantitative analysis, that the financial investment community tends to discount long term cash-flows excessively, therefore preferring short term returns above long term returns.
Using data over the past twenty years on dividends paid by companies and its outstanding shares, dividend per share is calculated. The geometric mean of the dividend per share over these twenty years is used to predict the growth rate of the dividend in the future. The expected dividend per share is then discounted by the cost of equity of the firm, which is calculated by means of the Gordon-Shapiro Model. Then the percentage of the current stock price that is still to be paid out in dividend by a company after five, ten, fifteen or twenty years can be calculated. In this paper these results are ordered by the firms country of origin, making an international comparison possible. All 57 firms examined in this paper are from either the United States, The Netherlands, Belgium, Great Britain or Germany. The results are also assorted by the size of the firm, dividing the sample into four groups: small firms, medium-small firms, medium-big firms and big firms. Market capitalization of the firms is calculated to determine its size. This makes a comparison of the results possible between the bigger and smaller firms. These international and size-based comparisons on the fraction of the current stock price that is still to be paid out in dividend after a period of time, make this paper unique and therefore relevant regarding the already existing literature.
I document that the firms from The Netherlands are the most long term oriented in this sample, followed by the firms from the United States, both having an above average percentage of the current stock price still to be paid out in dividend after all four time horizons. On the contrary, the German firms, followed by respectively the Belgian and British firms, are the most short term oriented firms in this sample, all three having a below average percentage of the current stock price still to be paid out in dividend after all four time horizons.
a below average percentage of the current stock price still to be paid out in dividend after all four time horizons.
This paper adds to the debate on short-termism on stock markets using the Gordon-Shapiro Model to calculate this short or long term. It also provides a valuable insight in whether or not there are differences between firms of different sizes and firms from different countries regarding short-termism.
The research is structured as follows: in Section 2 an overview of the available literature is given as well as the relevant theories from which the hypothesis are derived. Section 3 presents the methodology used for this research. Section 4 contains the results. The study is closed with a concluding summary and discussion.
The central research question to be answered in this paper is as follows:
2. Theoretical framework
This chapter briefly describes the long history of the discussions on short-termism by the investment community, followed by the relevant theories, from which the hypotheses are derived.
2.1 Literature review
The time horizons of markets have been the topic of several studies in the past. Jevons (1888) already wrote about the fact that everyone is completely occupied by the current pleasures and troubles, resulting in the undervaluation, or even neglecting, of future outcomes. Jevons’ opinion on short-termism was shared by Marshall (1920) and Pigou (1932) who respectively wrote about picking the plumbs out of the pudding to eat them all at once and a disability to look forward, resulting in undervaluation of the good things to come in the future.
Despite the above mentioned concerns raised on this topic in the late 19th and early 20th century, empirical and quantitative analysis on the real prevalence and impact of short-termism is scarce. Miles (1993) can be seen as one of the pioneers in this regard. He adapted and enhanced the basic asset pricing framework in order to analyse whether short-termism was present in the United Kingdom between 1980 and 1988. Using this methodology he was able to proof that the financial investment community tends to discount long term cash-flows excessively, therefore preferring short term returns above long term returns.
conclusion as Miles: the fact that the financial investment community fail to assess the value of future cash-flows, therefore preferring short term returns above long term returns.
Haldane and Davies (2011) studied the pricing of the equity of companies in order to check for occurrence of short-termism by using the asset price framework created by Miles (1993) as referred to earlier. Their results, which turned out to be both statistically and economically significant, not only proved the presence, but also the overtime increase of short-termism: myopia is ascending. According to the empirical evidence gathered by these authors, long term returns are over-discounted with between five and ten percent, making short term returns more attractive. Haldane and Davies (2011) conclude that choices of investment are being recalibrated to a shorter time horizon, stressing the increase in necessity for public policy intervention to restore the capital market.
All these authors focused on short-termism and on how to meticulously assess the prevalence of this phenomenon by quantitative means. That this work has not been in vain is proven in for example an article by Barton et al. (2017). The authors found out that from 2015 on, companies from idea-intensive industries, a software company for example, were among the most short term oriented, whereas companies from capital intensive industries, energy and telecommunications companies for example, were among the most long term oriented. Also, the firms with a longer time horizon exhibit stronger fundamentals and performance according to the authors, showing a cumulated growth of 47 percent more on average than the other firms. These firms also hand over better statistics on their financial performance, adding $7 billion on average more to their market capitalization than the other firms. Long-termism also seems to have a positive effect on job creation, which in the end influences the overall welfare in a country.
are non-existing. They see probable opportunity costs in investments that fail to occur due to a focus on the shorter term instead of a focus on the longer term, leading to a lower total revenue on the long term. Haldane (2015) confirms this conclusion, stating that short-termism might encourage firms to spend a large amount of their revenue on dividend for their shareholders, thereby failing to put that money back into the firm to secure future growth opportunities, therefore putting the complete company at risk on the long run. The proof of relevance is also supported by Froot, Scharfstein and Stein (1992) with their research on informational inefficiencies in a market with short-term speculation. They conclude that all traders might focus on the same information instead of focusing on a more diverse set of information in case of short-termism, resulting in information spill-overs.
2.2 Theories
received. These illiquid assets are referred to by the author as the goose who lays golden eggs: these assets assure to make for a huge benefit on the long term horizon, but it is not possible, at least very hard, to encash these benefits right away.
Based on this hyperbolic theory, the fact that smaller, sooner rewards are preferred above bigger, later rewards, the hypotheses for this paper are as follows:
H1: The degree of short-termism on stock markets differ per country of origin of the firms.
3. Methodology
This chapter explains the methodology used in this research, starting off with the introduction of the sample for this research as well as its sources its gathered from. Subsequently, the way the available data is to be analysed is being considered.
3.1 Sample
The sample for this research consists of yearly data on the total dividends paid and the shares outstanding over the period 1998 till 2017 for in total 57 companies. Twenty companies from the United States (included in either the NASDAQ-100 or Dow Jones Industrial Average), ten companies from the United Kingdom (included in the FTSE 100) and Germany (included in the DAX), nine companies from Belgium (included in the BEL 20) and eight companies from The Netherlands (included in the AEX). This leads to 2280 observations in total. These are all gathered from Compustat Global and Compustat North America through Wharton Research Data Services (WRDS).
Data on the current stock prices for the companies included in this research is hand collected from the respective stock market indices.
3.2 Data analysis
(1)
The now known growth rate is then used to predict the expected dividend per share for the coming twenty years, by multiplying the dividend per share for 2017 by the growth rate. This is shown in Equation (1).
𝐸(𝐷𝑖𝑣)𝑛 = 𝐷𝑖𝑣0(𝑔)𝑛
where E(Div)n is the expected dividend per share in year n, Div0 is the dividend per share in 2017, and g is the growth rate of the dividend.
The expected dividend now gathered, does not reflect its present value. The present value of the expected dividend is necessary to make the expected dividend comparable to the current stock price. The method used to determine the present value, is based on the Dividend Discount Model, as introduced by Gordon and Shapiro (1956), commonly referred to as the Gordon Growth Model or the Gordon-Shapiro Model (G-SM). The G-SM is in its essence a method to calculate the value of a company’s stock by means of the net present value of future dividend. In this paper the G-SM will be used in order to determine how much of the current stock price is paid out in dividend after five, ten, fifteen or twenty years. The formula of the original G-SM is given below in Equation (2).
𝑃 =𝐸(𝐷𝑖𝑣) r𝑒 − g
where P is the current stock price, E(Div) is the expected dividend per share, re is the cost of equity, and g is the growth rate of the dividend.
As already referred to, for this research I use another form of the G-SM, since the cost of equity is the unknown value in this case. Therefore, the adjusted formula of the G-SM is given below in Equation (3).
(3) (4) (5) 𝑟𝑒 = 𝐸(𝐷𝑖𝑣)1 P + 𝑔
where re is the cost of equity, E(Div)1 is the expected dividend per share in 2018, P is the current stock price, and g is the growth rate of the dividend.
The expected dividend as calculated in Equation (1) can now be discounted by means of the cost of equity calculated in Equation (3). This is done by dividing the expected dividend for year n by 1 plus the cost of equity to the power of n. This is shown in Equation (4).
𝑃𝑉𝐸(𝐷𝑖𝑣)𝑛 = 𝐸(𝐷𝑖𝑣)𝑛 (1 + 𝑟𝑒)𝑛
where 𝑃𝑉𝐸(𝐷𝑖𝑣)𝑛 is the present value of the expected dividend per share in year n, E(Div)n is the expected dividend per share in year n, and re is the cost of equity.
When Equation (4) is filled in with the earlier equations Equation (1) and Equation (3) this leads to one final equation, Equation (5).
𝑃𝑉𝐸(𝐷𝑖𝑣)𝑛 = 𝐷𝑖𝑣0(𝑔)
𝑛
(1 +𝐸(𝐷𝑖𝑣)P 1+ 𝑔)𝑛
where 𝑃𝑉𝐸(𝐷𝑖𝑣)𝑛 is the present value of the expected dividend per share in year n, Div0 is the dividend per share in 2017, g is the growth rate of the dividend, E(Div)1 is the expected dividend per share in 2018, and P is the current stock price.
of 1 January 2018. These percentages then reflect the part of stock price that will be earned back by the investor by means of dividend over each of the four respective time horizons. These percentages are then subtracted from 100% to, resulting in the percentage of the current stock price that is still not paid back to the investor by means of dividend after these five, ten, fifteen and twenty years. The lower these percentages, the more short term oriented these firms are and, on the contrary, the higher these percentages, the more long-termism is pursued.
These percentages make it possible to make a comparison of the statistics on short-termism between the different countries from which firms are included in the sample.
In order to make the same comparison of the statistics, but then based on the size of each firm, the market capitalization is calculated by multiplying the current stock price with the shares outstanding. Subsequently the firms are ordered on market capitalization and are divided into four groups, with each group consisting of approximately 25% of the firms in the sample. One group representing the small firms, one group representing the medium-small firms, one group representing the medium-big firms and one group representing the big firms.
4. Results
Table 1 describes the data used for this research. Most of the firms included in this research are from the United States: 20 out of 57 firms. Also, the mean market capitalization is the highest in the United States, 134,566 billion euros, with Belgium, 8,142 billion euros on the other side of the spectrum having the lowest mean market capitalization. Another salient detail that catches the eye, is the negative mean dividend growth rate for the companies from The Netherlands, whereas all other countries do have a positive growth rate. This is mainly due to two companies, Koninklijke Vopak N.V. and Aegon N.V., who report a significant decline in dividend per share over the past 20 years. Due to the relative small data sample, it should be borne in mind that the results from my observations might not be representative for the respective countries and groups of firms as a whole.
Table 1
This table shows some statistics that describe the data used for this research, with the mean market capitalization as of 01-01-2018 in billion euros.
Number of firms Mean market capitalization, billion €
In Table 2 the statistics on the cost of equity of the firms, used to calculate the present value of the expected dividend, are given. The firms from The Netherlands have the lowest mean, which is not surprising since Table 1 already provided us with the fact that these firms also have the lowest, and even negative, mean dividend growth rate. This growth rate is used in the calculation of the cost of equity, as stated in Equation (3) in Section 3.2. The relative high standard deviation for the Dutch firms implies that the cost of equity tend to be further away from the mean than in the case of the firms from other countries. In both Great Britain and Germany the cost of equity has a relatively low standard deviation, implying that the cost of equity is closest to the mean for firms in these countries.
Table 2
This table shows the statistics on the cost of equity calculated by means of Equation (2) in section 3.2.
Mean Std. dev. Median Min Max
USA 0.11197 0.07451 0.10828 -0.00678 0.30252 NLD 0.00056 0.11718 0.04016 -0.20792 0.11483 BEL 0.06349 0.05061 0.07780 -0.04269 0.11647 GBR 0.12425 0.04706 0.11241 0.06176 0.23307 GER 0.10436 0.04347 0.10181 0.01394 0.16864 All 0.08950 0.08151 0.09292 -0.20792 0.30252
The results of the summed up discounted expected dividend in percentages of the stock price as of January 1st, 2018 that still has to be paid out after five, ten, fifteen and twenty years is shown per country in Table 3 in respectively Panel A, Panel B, Panel C and Panel D.
that has still to be paid out is higher than the average. On the contrary, Belgian, German and British countries are more short term oriented than average.
United States’ firms have the lowest standard deviation on each and every of the four time horizons. The other four countries start off with standard deviations between five and six percent on a five years’ time horizon. After twenty years however, the standard deviation of firms from Belgium, Great Britain and Germany have risen to thirteen to sixteen percent, whereas the standard deviation of the Dutch firms have risen the fastest, to more than eighteen percent. This is not a surprise, since we already found out earlier that the Dutch sample included some firms with a very low growth rate on dividend per share, which enlarges the gap between firms over time.
Due to this it is also not a surprise that the overall maximum percentage on all four time horizons, is provided by the Dutch firms. In the meantime the German firms provide the overall minimum percentage on all four time horizons, while also having the lowest mean percentage on these time horizons.
From my observations, this makes the German firms the most short term oriented firms in this sample, followed by the Belgian firms and the British firms. The firms from The Netherlands are, from my observations, the most long term oriented in this sample, followed by the firms from the United States. Therefore, Hypothesis 1 is not rejected.
Table 3
This table shows the statistics of the amount of the stock price (as of 01-01-2018) that has still to be paid out in dividends after five (Panel A), ten (Panel B), fifteen (Panel C) and twenty (Panel D) years per country.
Panel A: 5 years
Mean Std. dev. Median Min Max
Figure 1
This figure shows the percentage of the stock price as of 01-01-2018 that has still to be paid out in dividends by the firms on average per country. The lower the percentage, the more short term oriented the firms in that respective country are.
The results of the summed up discounted expected dividend in percentages of the stock price as of January 1st, 2018 that still has to be paid out after five, ten, fifteen and twenty years is shown per firm size in Table 4 in respectively Panel A, Panel B, Panel C and Panel D. The firm size is determined by splitting up the firms in the sample in the 25 percent smallest, 25 percent medium-small, 25 percent medium-big and 25 percent biggest firms.
From this table it can be derived that the 25 percent smallest firms have the lowest mean on all four time horizons. Both the medium-small and the biggest firms score above average meaning that these firms are more long term oriented than on average, whereas the medium-big firms score below average.
The 25 percent smallest firms also have the highest standard deviation on all four time horizons, while the biggest firms are more consistent and have the lowest standard deviation on all four time horizons. This is also reflected by the minimum and maximum percentages, because these
0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 70,00% 80,00% 90,00% 100,00%
NLD BEL USA GBR GER
percentages are closest to each other for the biggest firms and most distant from each other for the smallest firms.
Based on this table it can be concluded that, from my observations, the medium-small companies are the most long term oriented, followed by the biggest 25 percent of the firms in this sample and the medium-big companies. The smallest 25 percent of the firms in this sample are the most short term oriented. Therefore, Hypothesis 2 is not rejected.
Table 4
This table shows the statistics of the amount of the stock price (as of 01-01-2018) that has still to be paid out in dividends after five (Panel A), ten (Panel B), fifteen (Panel C) and twenty (Panel D) years per company size. Based on the market capitalization, the first 25% are the smallest 25% firms of the sample, whereas the fourth 25% are the biggest 25% firms of the sample.
Panel A: 5 years
Mean Std. dev. Median Min Max
Figure 2
This figure shows the percentage of the stock price as of 01-01-2018 that has still to be paid out in dividends by the firms on average per size-based firm group. The lower the percentage, the more short term oriented the firms in that respective group are.
0,00% 10,00% 20,00% 30,00% 40,00% 50,00% 60,00% 70,00% 80,00% 90,00% 100,00% 1st 25% 2nd 25% 3rd 25% 4th 25%
5. Concluding remarks
5.1 Conclusion
The international comparison of the firms, resulted in the main conclusion that from my observations, the German companies are most short term oriented, followed by respectively the Belgian and British firms. The Dutch companies turned out to be the most long term oriented, followed by the firms from the United States.
The comparison based on firm size, resulted in the main conclusion that from my observations, the medium-small companies are the most long term oriented, followed by the biggest 25 percent of the firms in this sample. The smallest 25 percent of the firms in this sample are the most short term oriented, followed by the medium-big companies.
5.2 Discussion
The conclusion of this research is limited by its relative small amount of firms underlying the results that lead to this conclusion, although the data per firm is pretty comprehensive. The addition of extra firms could therefore have an impact on the overall results.
Another limitation is the fact that the stock markets analysed in this paper are all markets of western countries, mainly due to the data currently available. This could exclude interesting data on firms from all over the world.
Furthermore, it would be very interesting to compare more distinct countries from all over the world on short-termism. Due to complete different circumstances the results might be much more distinct as well.
Moreover, future research could also focus on making a comparison of short-termism over time, because that would give a valuable insight in whether or not firms have become more or less short term oriented through the past.
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