April 3, 2011
Dallas on Short-Termism and the Financial Crisis
Short-Termism, the Financial Crisis and Corporate Governance, by Lynne Dallas, University of San Diego School of Law, was recently posted on SSRN. Here is the abstract:
This paper is a comprehensive exploration of why financial and non-financial firms engage in short-termism with particular attention given to the financial crisis of 2007-2009. Short-termism, which is also referred to as earnings management or managerial myopia, consists of the excessive focus of corporate managers, asset (portfolio) managers, investors and analysts on short-term results, whether quarterly earnings or short-term portfolio returns, and a repudiation of concern for long-term value creation and the fundamental value of firms. This paper examines how market and internal firm dynamics contribute to short-termism by considering various structural, informational, behavioral and incentive problems operating within firms and markets.
Regarding structural problems, this paper explores how the internal dynamics of traditional and shadow banks contribute to short-termism. It also explores the contribution of short-term (high turnover) trading, including momentum and high frequency trading, to short-termism. It examines the role of "dumb money" (noise traders) in causing overvalued equity resulting in over-investments by non-financial firms, and the role of transient institutional investors in contributing to earnings management by managers of non-financial firms. It also addresses the ability of activist shareholders through the use of shareholder voting rights or takeovers to use non-financial firms as short-term arbitrage opportunities.
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