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

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.