Don’t Let the Short-Termism Bogeyman Scare You

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance, at Harvard Law School. This post is based on his article in the current issue of the Harvard Business Review. Related Program research on short-termism includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), and Should Short-Term Shareholders Have Less Rights? by Lucian Bebchuk and Doron Levit.

The current issue of the Harvard Business Review contains an article I wrote entitled Don’t Let the Short-Termism Bogeyman Scare You.

The current issue of the Harvard Business Review also includes, as many prior issues have included, an article decrying the perils of short-termism and supporting measures for insulating corporate leaders from the outside pressures that allegedly make them myopic. The aim of my article is to show that, despite the alarming rhetoric of arguments supporting such measures, they are short on empirical evidence or economic logic. Furthermore, these arguments overlook substantial benefits that outside investor oversight produces and that such measures would sacrifice.

Harvard Business Review readers have been warned about the dangers of short-termism for at least four decades. In their 1980 article “Managing Our Way to Economic Decline,” Robert Hayes and William Abernathy argued that the short-term focus of corporate managers was to blame for a “marked deterioration of competitive vigor.” Similarly, in his 1992 article “Capital Disadvantage: America’s Failing Capital Investment System,” Michael Porter claimed that short-termism was causing underinvestment in long-term R&D projects and was the reason that “the competitive position of important U.S. industries has declined relative to other nations, notably Japan and Germany.”

Although short-termism has not produced the predicted demise during the decades that have passed since, calls to protect corporate leaders from pressures that could induce short-termism have persisted if not intensified. Indeed, such arguments have long been advanced as a key reason for supporting measures—such as takeover defenses, staggered boards, dual-class share structures, and dual-class recapitalizations—that limit the power of shareholders and insulate corporate leaders.

Unfortunately, the superficial appeal of such arguments has won over many institutional investors and public officials. It is important that they and others recognize the shortcomings of the short-termism claims. My article seeks to highlight these shortcomings, and below I note several elements of my analysis:

Does the Market Underestimate Long-Term Projects? A major premise of short-termism worriers is that markets systematically undervalue long-term investments, which are consequently not fully reflected in stock prices. However, as my article explains, although markets do sometimes err, the view that markets systematically undervalue long-term investments is not supported by the evidence. Indeed, over the past two decades, as dire warnings regarding short-termism have proliferated, growth companies—whose value largely reflects expectations about their payoff in the long term—have enjoyed substantial appreciation in value. Companies in the tech-heavy Nasdaq 100 now make up more than a quarter of the total capitalization of U.S. stock markets; and they are trading at a high price/earnings ratios, reflecting the markets’ willingness to attach great value to companies on the basis of their future prospects rather than their current earnings.

Of course, some corporate leaders may take the view that the market doesn’t adequately appreciate the long-term prospects of their companies and consequently underprices their stock. But such reactions may simply reflect the tendency of those individuals to overvalue or defend their own performance. Even if stock market price disappoints a company’s leaders, it may in fact accurately value the company’s long-term prospects rather than fail to do so.

Is Hedge Fund Activism Detrimental? Short-termism worriers view hedge fund activism as a menace. Consequently, they support measures that impede it and urge other investors to avoid supporting activists. However, as my article explains, this view reflects a flawed assessment of the effects of activism. The evidence (see, for example, my study with Alon Bran and Wei Jiang) does not support the concerns of short-termism worriers that engagements by activist hedge funds are followed by adverse long-term effects to returns or performance.

Moreover, these worriers overlook a significant beneficial effect that the prospect of hedge fund activism should be expected to have on the performance of those corporate leaders who seek to avoid it. The threat of such intervention should be expected to discourage managerial slack and underperformance, thus playing an important disciplinary role and incentivizing leaders to enhance shareholder value.

Long-Term and Short-Term Investors: Foes or Allies?  Those who want to protect corporate leaders from market pressures often distinguish between long-term investors (“good”) and short-term investors (“bad”) and view all hedge fund activists, even those who hold positions for a substantial time, as the latter. Short-termism worriers urge long-term investors to view the influence of short-term investors as detrimental and to support insulating managers from such influence. According to this view, long-term investors should generally lend their support to management and avoid cooperating with hedge fund activists.

As a study by Doron Levit and I shows, however, this view suffers from significant flaws. For one, even investors who plan to hold their shares in a company for a very long time should hardly be uninterested in short-term results; looking for long-term value does not mean leaning back and counting on managers to deliver such value. Even long-term investors should be keenly interested in interim results, which may signal needed changes in management or governance.

Furthermore, long-term investors often benefit from the work of hedge fund activists, who usually cannot effect change unless other investors are willing to support their proposals. And other investors should be expected to provide such support only if they believe that they, too, will benefit from proposed changes. Moreover, if the prospect of an activist intervention discourages managerial slack and underperformance, all the company’s investors are rewarded.

Internally-Driven Short-Termism: Although there is currently no basis for viewing short-termism problems as sufficiently severe to justify insulating managers, there is still significant room for improvement in the governance of public companies in general and in decision-making about long-term projects in particular. In particular, as Jesse Fried and I explained in our book and subsequent work, arrangements that provide short-term incentives persist largely because they serve executives’ private interests and not because of outside pressures from investors and markets.

Unlike measures that insulate corporate leaders from investor oversight and intervention, a redesign of executive pay arrangements would temper short-termism without imposing large costs arising from increased slack and underperformance. Therefore, those who are concerned about short-termism should focus on reforming pay arrangements before considering the adoption of measures that would insulate managers and bring about such costs.

The Folly of Going Back: Insulation advocates essentially seek to reverse the effects of largely beneficial developments that have taken place over the past several decades. During this period, the rise of institutional investors has led to a concentration of ownership that introduced the possibility of meaningful investor oversight. Although such oversight may have some adverse effects, overall it is a substantially beneficial mechanism that serves the interests of investors and the economy. Measures to weaken it would move us in the wrong direction.

***

Warnings of the perils of short-termism are repeatedly used to support shielding managers from outside pressures and oversight. But those warnings are not supported by evidence regarding the severity of the alleged short-termism effects, and they overlook important benefits provided by market and investor oversight. Fears of the short-termism bogeyman should not scare us into supporting measures that insulate managers. Adopting or maintaining such measures would operate to the detriment of American investors and the U.S. economy.

My article is available here. It draws on three more extensive academic studies, The Myth That Insulating Boards Serves Long-Term Value, The Long-Term Effects of Hedge Fund Activism (with Brav and Jiang), and Should Short-Term Shareholders Have Less Rights? (with Levit). My work on the subject of short-termism is ongoing and comments from readers are welcome.

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One Comment

  1. ira kay
    Posted Thursday, February 4, 2021 at 4:20 pm | Permalink

    Thank you Lucian, for another excellent and persuasive article. We completely agree that the “short-termism” critique of American companies is completely overblown and likely wrong. As Steve Kaplan from Booth explains it, critics have been accusing US business of short-termism for nearly 40 years. There should be supporting evidence of this myopia, but these is very little. We have done research [Harvard Law Forum 10/25/2019] testing whether shareholders consider stock buybacks to be myopic at the cost of investment and R&D; whether executive compensation [stock options and eps] motivates myopia, and whether companies with strong short term performance underperform in the long run. We answer all 3 questions in the negative. However, we disagree with Lucian’s criticism that CEO pay causes myopia. CEO pay has been denigrated for causing problems including myopia, far longer than myopia itself and yet there is no evidence. Yet there is evidence of the great success of the US CEO pay model. Lucian’s paper adds to the evidence as he persuasively argues that there is no myopia. We work with the boards of hundreds of companies and the executives/boards seem to balance the short-and long-term extremely well.

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