The Puzzle of UK (Under‐) Investment: Is Investment Short‐Termism Just a Supply‐Side Problem in Capital Markets?

Abstract

Investors and financial market intermediaries have been blamed for under‐investment, low growth and low rates of innovation in the UK, with their behaviour being attributed to short‐termism. Various reasons for short‐termism have been identified, including undervaluing long‐term earnings, increased financial obstacles associated with longer investment horizons, and the adoption of financial control systems to meet investors’ demands for quarterly earnings reports. As a result, firms may opt for suboptimal short‐term investment projects while neglecting potentially valuable long‐term initiatives. Most research has focused on large corporates, which constitute a small fraction of the economy and involve multiple stakeholders. There is a significant knowledge gap regarding small owner‐managed firms that rely primarily on internal financing and bank debt for investment. Our study fills this gap by analysing a comprehensive UK finance and investment decision‐making survey of 1501 firms across all classes. The survey reveals that investment appraisal relies on a ‘payback’ period. We find that 58.8% of firms choose a payback period of 3 years or less, with shorter payback periods more prominent among the smallest firms. This suggests that financial frictions impact the investment behaviour of the smallest firms, while shareholder‐driven short‐termism influences the largest firms but only in relation to research and development projects.