Wednesday, December 2, 2015
I am about 10, if not 15 years late to this party. This is not a new question: have investment time horizons shrunk, and if so, in a way that extracts company value at the expense of long-term growth and sustainability?
Since this isn’t a new question, there is a considerable amount of literature available in law and finance (and a definition available on investopedia). This may seem like great news, if like me, you are interested in acquiring a solid understanding of short termism. By solid understanding, I mean internalization of knowledge, not mere familiarity where I can be prompted to recall something when someone else talks/writes about it. I have some basic questions that I want answers to: What is short-termism?, What empirical evidence best proves or disproves short-termism? Which investors, if any, are short-term? What are the consequences (good and bad) of a short-term investment horizon? If there is short-termism, what are the solutions? I’ll briefly discuss each below, and my utter failure to answer these questions with any real certainty thus far.
What is the definition of short-termism and does it change depending upon context or user? There appears to be consensus on the conceptual definition of foregoing long-term investments in favor of corporate policies maximizing present payouts like dividends and stock buy-backs among hedge funds. As for what determines “short-term” with institutional investors- responsiveness to quarterly earnings? Over-reliance on algorithmic trading models? The definition gets less clear when we start looking at different types of investors.
How can one test the presence of short-termism? Stock holding patterns and redemption rates and turnover would be the obvious answers. This information is hard to aggregate, much of it is proprietary. Second, the issue of outliers, like high value high-frequency trades, may distort the view if most shareholders or at least the most influential shareholders like institutions, aren’t operating with a short-term time horizon. But that can mean different things for different investors. Once again which investors we are looking at drives this question in part.
This brings us to the next question, WHO might be short term? Hedge Funds? Institutional Investors like pensions and mutual funds? High Frequency Traders? Retail investors? Retirement Investors (I call these folks Citizen Shareholders)?
Looking to the next question: what are the consequences of a short-term investment horizon? Shareholders like hedge funds whose investment model differs from institutional investors, often employ shareholder activism to change management and corporate policies as a means to increase the share value of the company, after which the fund usually divests significantly, if not completely. The evidence here too is mixed (see e.g., conflicting findings by Bebchuk & Coffee).
For many the anecdotal evidence of short-termism pressures coming from board rooms is powerfully persuasive and hard to ignore even where researchers can’t pin down the source. I don’t use anecdotal in a derogatory sense at all, there is truth in experience and limitations in our ability to quantify naturally occurring phenomenons. Perhaps the question of short-termism is like trying to identify what smells bad in a pantry. You know it is there; finding the cause is much more difficult. Consider the position of Martin Lipton who wrote in response to the Bebchuk article:
"To the contrary, the attacks and the efforts by companies to adopt short-term strategies to avoid becoming a target have had very serious adverse effects on the companies, their long-term shareholders, and the American economy. To avoid becoming a target, companies seek to maximize current earnings at the expense of sound balance sheets, capital investment, research and development and job growth."
Also consider a survey of corporate board members reported that over 60% felt short term pressure from investors. It is a real problem to directors and one that corporate governance cannot ignore. A fair question to ask is whether or not the fear is misstated or if the concern is another way of arguing for greater control. And this brings us to the last question.
If there is short-termism, what are the solutions? Aligning corporate managers/directors incentive payments has been critiqued. Giving corporate boards more power and isolating them from shareholders tips the scales of the corporate power puzzle heavily towards managers which brings threats of agency costs and managerial abuses. But on the other hand, if a short-term investment perspective extracts company value in a way that causes externalities that undercuts the contractarian argument for shareholder primacy. If shareholders’, or at least some shareholders’, primary investment stake isn’t to be residual claimants in the traditional sense then their incentives aren’t aligned with the interests of other stakeholders. Those shareholders aren’t acting in everyone’s best interest. The debate often devolves into one of consequences, or perhaps it is the starting point for many who write in the area. If short-termism doesn’t exist or isn’t bad then there is no push back on shareholder primacy. If short-termism does exit and it does cause externalities then it is a powerful argument in favor of director primacy.
I am weeks into this inquiry and all I have done is further confuse myself about what I thought I knew, expanded my questions list and flooded my dropbox with articles (tedious, dense, often empirical articles).
A few things have come out of this quagmire. First, I have great discussion points for my corporate governance seminar and certainly a supplemental segment for my casebook. Second, I am increasingly thinking the tremendously important insights provided by many law and finance scholars isn’t the complete picture. I can’t get to the bottom of this question, because there might not be one (or one that I understand) yet. So where are the gaps? What do we still need to know to further explore this topic? These big, heavy, interdisciplinary questions are hard to tackle alone at our desks and benefit from engagement, dialogue, and rapid fire thinking that takes places at conferences/symposiums.
In terms of blogging, let’s focus back on you readers. I’ll check back in periodically on this topic by sharing my reading list on the topic and also highlighting some of the articles on my list. If you have a seminal article that you found help explain short-termism to you (or your students) please share. If you are working on any papers in this area, please email me separately (email@example.com) as I am working on putting together a symposium for summer 2017.