The Power of the Narrative in Corporate Lawmaking

Mark J. Roe is David Berg Professor of Business Law at Harvard Law School, and Roy Shapira is Associate Professor at IDC Herzliya Radzyner Law School. This post is based on their recent paper, forthcoming in the Harvard Business Law Review. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here); and Stock Market Short-Termism’s Impact by Mark Roe, (discussed on the Forum here).

The concept of how stock-market-driven short-termism damages the economy is simple and powerful: executives, confronted with a demanding stock market of traders and activists, focus too much on boosting the immediate quarterly financial statements, rather than on the business’s long-term health. Employee well-being, critical research and development, and long-run capital investment all deteriorate. As a result, the entire economy suffers. Among policymakers, the media, and executives, the consensus is that the short-termism problem is widespread and pernicious—and getting worse. Presidents and presidential candidates say so. Corporate law judges excoriate it. Stock market regulators, responding to political pressure, move combatting short-termism up on their agenda.

Yet the academic evidence for stock-market-driven short-termism as seriously damaging the economy is inconclusive and contested. Surely some companies are, as charged, excessively short-term. But the evidence of grave economy-wide damage is sparse and some of it negative. What explains this wide gap between contradictory academic evidence and assured perniciousness in the popular view?

In our recent paper, titled The Power of the Narrative in Corporate Lawmaking (forthcoming in the Harvard Business Law Review), we explore the role of narrative power. Some ideas are better at being popular than others. With short-termism, the idea is popular not because the evidence is conclusive and severe but because the negatives are easily stated, easily understood, and regularly repeated, while the positives (although they appear in the data) need a few moments to visualize and articulate. We highlight the psychological, behavioral bases that make the strongly negative narrative quite believable on its own, as well as the interest-group dynamics that the narrative bolsters. The narrative is persuasive on its own and is also firmly pushed by those who benefit from its being widely believed.

The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: connotation, category confusion, and confirmation.

Connotation and vocabulary matter. Initial connotations condition our thinking before we examine evidence. With “short-termism,” the initial connotations—of instability, unreliability, uncertainty, and a refusal to follow through—make it seem much worse for corporate strategy than it is. By contrast, long-termism’s connotations—of reliability, steadfastness, and stable planning—make it seem more desirable. The words themselves evoke a mental image of stock traders frenetically buying and selling, in contrast to construction workers in hard hats building a durable factory. A deeper analysis than most people’s initial impression would point out that the converse is also important to consider: long-term corporate decisionmakers can be stubborn and self-interested, while short-term decisionmakers can be flexible and innovative. Yet the public and political sensibilities often hinge on the immediate connotations.

Narrative power depends not just on the connotations that surround how our minds initially receive the idea, but also on how often our environment reminds us of the idea. This is where category confusion comes in. With corporate short-termism, salient phenomena not arising from distorted time horizons are regularly but incorrectly labeled as corporate short-termism. Environmental degradation, for example, is often portrayed as due to stock-market short-termism, when it primarily emanates from the corporation’s ability to offload costs externally to third parties, not from investors’ time horizon. The corporation cheapens its operations to save money at the environment’s expense, thereby benefiting not just short- but also long-term investors. The real policy issue is who pays, not when they pay. But when disparate problems such as toxic pollution or employee mistreatment are mislabeled and lumped with truly short-term phenomena (of distorted corporate time horizons), policymakers and the public view short-termism as more rampant and pernicious than it is.

Confirmation and repetition further bolster the belief that it is a major economy-wide problem. The idea is boosted by both naturally-recurring repetition, and intended, interest-driven repetition. Naturally-recurring confirmation comes not just from the real instances of time distortion but also from the just-mentioned category confusion. Interest-driven repetition comes from influential players—namely executives and directors—who benefit if lawmakers believe financial market short-termism is pernicious enough to justify further executive autonomy from financial markets. Since some firms surely are perniciously too short-term, these influential agenda-setters can sincerely and vividly identify, emphasize, and replay discovered instances and build supporting narratives. Negative stories of short-termism transmit well, whereas stories of positive aspects of market feedback to end poor investments are complex and opaque, often dying before their retelling. Connotation, confusion, and confirmation thus combine to make the short-termism narrative popularly seen as a major cost to the economy.

The paper then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure (as we document in our paper by looking, among others, at Martin Lipton’s posts in this blog). If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic research and development, employee mistreatment, and financial crises — as many do — then they are likely to focus on further insulating corporate executives from stock-market accountability. Doing so may, however, do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking

Other academic disciplines are moving faster than law in understanding how narrative power can determine business, economic, and political outcomes. Political scientists and sociologists have long acknowledged the role of narratives in driving lawmaking, and economists have begun recently to grapple with the idea (see a recent book by one Nobel Laureate, and a recent article by another). Corporate legal scholarship has thus far largely ignored narrative power, perhaps unsurprisingly: historically, the plumbing of corporate and securities law rarely engaged public sentiment, thereby making it understandable that corporate law analysis has traditionally focused on other factors, such as doctrinal path or corporate performance.

However, in an era of increasing populism and burgeoning social media, such as ours, popular narrative, widespread perception, and notions of how-it-will-play in the media are becoming increasingly important in corporate lawmaking. Corporate purpose, stock market short-termism, stock buybacks, and executive compensation are issues of popular and political discourse, not just of specialists’ analysis. A classic example comes from the 2019 Business Roundtable’ corporate purpose statement, and the flurry of popular media follow-ups it brought (not to mention numerous posts by academics and practitioners in this blog!). The kind of narrative analysis we blueprint here will therefore increasingly be needed to understand how corporate law is made.

Combining an attractive idea that is grounded enough in reality with plausible even if disputed evidentiary support can propel an idea farther and with more certainty than would the actual evidence alone. Influential interests cannot always obtain their goals unless those goals resonate with a narrative rhetoric that persuades lawmakers, voters, and the media. Narrative analysis is needed, and we expect will be needed more in the future, to explain why some corporate issues grip lawmakers and others do not.

The full paper is available for download here.

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