ARTICLE: Long-Term Investing as an Agency Problem
Concerns over short-termism within financial markets have led to calls for more long-term investing. Nevertheless, investors who genuinely pursue investing for the long run remain in the minority. The quandary of why long-term investing is not more prevalent can be better understood as an agency problem. Investing is often undertaken under principal-agent arrangements, particularly within investment organizations involving multiple layers of delegation. Meanwhile, long-term investing entails taking positions where the ultimate payoff may not arrive anytime soon, and is often subject to high and ongoing uncertainty. Two particular challenges arise. The first is securing alignment along the chain of delegations when horizons may differ. The second relates to the unavoidable need for principals to monitor agents, without having the option to reserve judgement for, say, 10 years. It is this potential discord in horizons – both between principals and agents, and between the investment and monitoring horizon – that makes long-term investing so difficult to pursue and sustain. We outline various facets of this issue, and offer solutions. In doing so, we take an institutional investor perspective. Our discussion is illuminated by the experiences of Australia’s sovereign wealth fund, the Future Fund, which is structured to align the Board, internal management and external managers with pursuit of a long-term approach.
Problems arise from differences in investment horizons; the tendency to evaluate and reward based on short-term results; and failure to commit. We delve into these issues, and offer some solutions.
The agency problems that pervade delegated investment management are exacerbated when investing for the long term, where the payoff is distant and often highly uncertain. These conditions compound the difficulty of aligning and monitoring the agents (managers) responsible for making investment decisions, particularly across multi-layered investment organizations. Problems arise from differences in investment horizons; the tendency to evaluate and reward based on short-term results; and failure to commit. We delve into these issues, and offer some solutions. Investment organizations intending to pursue long-term investing should aim to create an environment where all principals and agents along the chain of delegations are aligned, engaged on an ongoing basis, incentivized to work towards long-term outcomes, and committed to investing for the long run.
Research Working Paper, June 2015