A lack of trust and poorly-aligned incentives have pushed UK equity markets into a culture of “short-termism,” undermining their role of supporting innovative, sustainable long-term business performance, according to a new independent review from Professor John Kay.

In his review, UK equity markets and long-term decision making, Professor Kay calls for a “much-needed” shift in the culture of UK equity markets, based largely on the restoration of relationships built on long-term trust and confidence, as well as the realignment of incentives across the investment chain, said the Department for Business, Innovation and Skills, the government unit which commissioned the report.

While the report applies to the UK market, given the global nature of investment markets its findings are relevant globally.

According to the report, short-termism - or myopic behavior - is the “natural human tendency to make decisions in search of immediate gratification at the expense of future returns.” In a business context, the report explains that short-termism occurs when companies invest too little, either in the physical assets of the business or in the intangibles which are generally the source of their competitive advantage. It can also manifest in hyperactivity, such as frequent internal reorganization, corporate strategies designed around extensive mergers and acquisitions, and financial re-engineering which “may preoccupy senior management but have little relevance to the capabilities of the underlying business,” the report said.

Kay has underlined a set of principles to ensure that equity markets support their “core purpose” of enhancing the performance of UK companies and providing returns to savers; there is no “magic bullet” to deliver these outcomes, he warns, but advises that the recommendations laid out will help achieve a financial world which is “very different from our recent experience.”

“We must create cultures where business and finance can work together to create high-performing companies and earn returns for investors on a sustainable basis,” Kay said. “This means moving away from a focus on short-term transactions and trading to an environment based on long-term trust relationships.”

One issue highlighted in the review is that “information asymmetry and principal-agent conflict become steadily more serious as the modern corporate economy evolves.”

For example, as firms grow in size and complexity, shareholders “necessarily know less” about the businesses in which their funds are invested. “As companies become larger and shareholding more fragmented, relationships between savers and the management of the companies in which their funds are invested become more distant and the potential for their interests to diverge is increased,” the review explains.