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Univ. of Toledo College of Law

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Sunday, March 31, 2013

Roe on Short-Termism

Corporate Short-Termism - In the Boardroom and in the Courtroom, by Mark J. Roe, Harvard Law School; European Corporate Governance Institute (ECGI), was recently posted on SSRN.  Here is the abstract:
 
A long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying more judicial measures that shield managers and boards from shareholder influence, so that boards and managers are freer to pursue sensible long-term strategies in their investment and management policies.

Here, I evaluate the evidence in favor of that view and find it insufficient to justify insulating boards from markets further. While there’s evidence of short-term distortions, the view is countered by several under-analyzed aspects of the American economy, each of which alone could trump the board isolation prescription. Together they make the case for further judicial isolation of boards from markets untenable. First, even if the financial markets were, net, short-term oriented, one must evaluate the American economy from a system-wide perspective. As long as venture capital markets, private equity markets, and other conduits mitigate, or reverse, much of any short-term tendencies in public markets, then the purported problem is local but not systemic. Second, the evidence that the stock market is, net, short-termist is inconclusive, with considerable evidence that stock market sectors often overvalue the long term. Third, mechanisms inside the corporation are important sources of short-term distortions and the impact of these internal short-term favoring mechanisms would be exacerbated by further judicial insulation of boards from markets. Fourth, courts are not well positioned to make this kind of basic economic policy, which if determined to be a serious problem is better addressed with policy tools wider than those available to courts. And, fifth, the widely held view that short-term trading has increased dramatically in recent decades may over-interpret the data; the duration for holdings of many of the country’s major stockholders, such as mutual funds like Fidelity and Vanguard, and major pension funds, does not seem to have shortened. Rather, a high-velocity trading fringe has emerged, and its rise affects average holding periods, but not the holding period for the country’s ongoing major stockholding institutions.

The view that stock market short-termism should affect corporate lawmaking fits snugly with two other widely supported views. One is that managers must be isolated from stock markets to run the firm well. Whatever the value of this view, short-termism provides no further support for managerial insulation from financial markets. The insulation argument must stand or fall on its own. Similarly, those who argue that employees, customers, and other stakeholders are due more consideration in corporate governance point to pernicious short-termism to further support their view. Again, the best view of the evidence is that the pro-stakeholder view must stand on its own. It gains no further evidence-based, conceptual support from a purported short-termism in financial markets. Overall, system-wide short-termism in public firms is something to watch for carefully, but not something that today should affect corporate lawmaking.

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