Corporate Short-Termism – In the Boardroom and in the Courtroom

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Last month I posted to SRRN Corporate Short-Termism – In the Boardroom and in the Courtroom, which the Business Lawyer will publish this August.

In this paper, I examine 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.

However, when I evaluate the evidence in favor of that view, the evidence turns out to be insufficient to justify insulating boards from markets further. While there is 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 a short-term problem is potentially 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 insulation of boards from markets. Even if short-termism were in play, these negatives for potential solution need to be weighed in the mix.

Fourth, some of the focus on short-termism may have the effect of persuading courts to consider isolating boards from markets. But 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. Courts are reluctant to make narrower business judgments when reviewing the business decisions of boards. They should be even more reluctant to consider such economic policies as even tiebreakers in rendering normal judicial corporate decisions.

Lastly, 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 free from tight stockholder influence, because without that freedom boards and managers cannot run the firm well. Whatever the value of this view and however one judges the line between managerial autonomy and managerial accountability to stockholders should be drawn, short-termism provides no further support for managerial insulation from the influence of financial markets. The autonomy 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.

The full paper is available for download here.

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