A Deconstruction of the Short-Termism Thesis

Charles Nathan is Consulting Partner at Finsbury Glover Hering. Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); Don’t Let the Short-Termism Bogeyman Scare You by Lucian Bebchuk (discussed on the Forum here); Corporate Short-Termism – In the Boardroom and in the Courtroom by Mark J. Roe (discussed on the Forum here); and Looking for the Economy-Wide Effects of Stock Market Short-Termism by Mark J. Roe (discussed on the Forum here).

In the early 2020’s it is received wisdom in a broad swath of corporate America that stock market short-termism is a malady adversely affecting the future of public companies in the United States and increasingly around the world. This belief goes well beyond board rooms and executive suites, and finds a welcoming reception among many financial journalists, corporate law judges, a large number of academics in business and law schools, politicians on both sides of the aisle on Capitol Hill and denizens of the Executive Branch up to and including President Biden. In the all-too-common perception, hedge funds, so-called “activist” investors, rapacious private equity firms and, sadly, many institutional investors of otherwise stellar character are hell-bent on forcing corporate managers to forgo wealth-building long-term strategies and investments, particularly in R&D, capital investment and more equitable distribution of corporate revenues among the core corporate constituencies. Instead, according to the many vocal proponents of the short-termism thesis, the perpetrators of short-termism are demanding that corporations engage in faddish financial engineering with the goal of maximizing short-term earnings, forcing corporate divestitures and break-ups, engaging in going private transactions and seeking sales and mergers—all solely to generate near-term stock price appreciation to reward the insatiable short-term focused stock market.

To be sure, there are some voices to be heard espousing the other side of the short-termism narrative. But whatever the merits of their arguments, there seems to be no question which viewpoint resonates the most widely and is clearly far ahead in the court of public opinion. This is not to say, however, that the alleged perpetrators of short-termism, principally activist investors and private equity firms, have receded from the scene. On the contrary, they are almost certainly more active and more richly financed today than at any time in our economic history. As a result, the drum beat of proposed cures for sort-termism is increasing in intensity and the possibility of legislative and regulatory counteractions seems to be growing.

As with all too many debates in our society and polity today, voices of reason seem few and far between. It is for that very reason, we should celebrate the publication of Professor Mark J. Roe’s new book entitled Missing the Target: Why Stock Market Short-Termism Is Not the Problem. Professor Roe’s book is a dispassionate, even-handed and persuasive deconstruction of the concept of stock market short-termism. The only reasonable conclusion from reading it is that short-termism is like the proverbial emperor with no clothes. It may be emotionally satisfying, but there is very little, if any, empirical evidence to support its main theses. It is, in other words, a theory in search of non-existing empirical support. It is more of a myth than a reality, and it should have no weight in policy decisions about the make-up of the modern corporation, its governance and its role in society, let alone in laws, regulations and court decisions impacting contests for corporate board seats and corporate control.

Roe begins with an explication of the stock market short-termism thesis and then examines whether there is any supporting macroeconomic data. He finds startling little to none. As he recounts, the apparent decline in capital spending by corporations following the Great Recession was more likely the product of excess capacity due to economic contraction than short-termism. Saliently, as the world’s economy recovered, capital spending again began to increase. Similarly, the oft-repeated claim that short-termism stifles R&D is not borne out by the macroeconomic data. On the contrary the data clearly shows rising corporate R&D spending over the last decade. The reduction in aggregate R&D spending is attributable not to corporate cutbacks but rather to governmental reductions in R&D outlays. Finally, Professor Roe demolishes the claim that massive corporate stock buybacks over the last decade have starved corporations of needed funds for R&D and capital investment. He points out that at the same time corporations engaged in equally massive borrowing which effectively off-set their spending on stock buybacks. Roe points to the obvious conclusion—corporations have substituted cheap debt for expensive equity without adversely affecting their liquidity. This may or may not be a desirable change in corporate financing, but it has not diminished corporate resources for investment in R&D and plant and equipment.

A hallmark of Roe’s book is its evenhanded and thorough examination of the empirical evidence on both sides of the short-termism debate. He does not stop with an examination of the macroeconomic data on both sides of the debate; he also examines in detail the microeconomic evidence and presents a compelling case that at best this evidence (consisting largely of so-called “event studies” by economists and lawyers) is inconclusive. More likely, he concludes, on careful analysis the proponents of short-termism fare far worse than those academics whose work suggests the absence of harmful effects attributable to the ravages of short-termism.

Professor Roe’s analysis of the short-termism thesis is inclusive. He does not ignore or short shrift arguments that short-termism is a cause of corporate indifference to, or worse degradation of, the environment or other issues comprehended by the ESG acronym. For example, he does not deny that corporations’ record on environmental safety is dismal, but he does convincingly argue that the cause is not the short-term viewpoint (or in his words the time horizon) of corporations. Rather it is due to the ability, at least to date, of corporations to off-load the cost of environmental damage onto the polity. As he points out, some of the worst “polluters” are corporations in the energy and chemical sectors, such as Exxon-Mobil and Dupont, which are (or were in their prime) the epitome of practitioners of long-term strategy and investment.

Not content with demolishing the empirical and theoretical case for short-termism, Roe turns to an evaluation of the commonly prescribed “cures.” The first, he points out, is increased insulation of management and boards from shareowners’ pressure through increased autonomy. In practice, this would entail measures such as less frequent board elections, board election rules designed to stymie shareholder activism and promotion of dual class stock structures. Other forms of amelioration would include changes in state corporate law, SEC regulations and tax law to advance anti short-termism policies. This could mean, for example, laws enhancing voting rights for long-term shareholders, discouraging, or prohibiting stock buybacks and eliminating quarterly reporting. Roe examines each of the proposed antidotes to short-termism and finds it ineffective, affirmatively counter-productive or at best tangential to the perceived evils of short-termism and inappropriate as a matter of policy.

Last Professor Roe turns to what he categorizes as the “politics” of the short-termism thesis. It is here that Roe identifies with telling accuracy the underlying psychological underpinnings of prevalence of the short-termism thesis. First, in his view, is the reality of disruption in the business world, our economy as a whole and our very ways of life created by the increasing pace of technological driven change. As so many have noted, this disruption leads to a myriad of social, economic, and psychological challenges which all too many find hard or impossible to surmount. For many in the business world, it is all too easy to blame the disruption on simpler and seemingly more sinister causes, short-termism being a prime example.

Roe likewise examines the “political” support for the short-termism thesis naturally emanating from the corporation itself. If the prescription of the short-term activist is change (of almost any type, let alone cataclysmic change such as a sale of the business), it is natural that the proposal will engender opposition from the core corporate constituencies of the board, management and labor. The fear of change caused by what they view as “outside” shareholders (whether in progress, threatened or merely inchoate) is more than sufficient to justify continuation of the status quo as being good for the long-term and the possible disruption as being short-sighted and destructive.

Nor are our society’s politics immune from an instinctive aversion to financial market short-termism. Since the United States was founded, there has been a strong populist sentiment against “Big Money” and “Wall Street.” The economic crisis brought on by the monetary bubble on Wall Street in 2008-2009—the so-called “Great Recession”—has reawakened the populist antagonism toward anything identified with Wall Street. Short-termism obviously fits this bill. Hence, in Roe’s view, anti-Wall Street sentiments easily transfer into an obvious support for the fight against stock market short-termism.

Roe makes one of his most insightful explanations of the popularity and prevalence of the short-termism thesis through his examination of the psychology of words and phrases. As he so cogently points out, the terms “short-term” and “short-termism” have very strong negative connotations. In contrast, the terms “long-term” and “long-termism” have very positive connotations. Put simply, labeling a proposal, policy or outcome as “short-term” immediately prejudices the hearer or reader to dislike it. This psychological reality helps explain the remarkable effectiveness of the corporate megaphone (hardly the most favored in our society) in transmitting fear of short-termism to others, be they judges, academics, journalists, regulators, politicians or the public.

What Roe subtly alludes to but does not explicate is that the use of the label “short-term” in the financial world originated in the wave of hostile tender offers that surfaced in the mid-1960’s and continued into the mid-1980’s. These seminal battles for corporate control seemingly came from nowhere to threaten a corporate culture in the US that knew nothing but consensual mergers for roughly a century. An early and increasingly potent rallying cry for embattled corporate interests (management, boards and often their lawyers) was that of short-termism. Branding the “raiders” as short-term stock market players allied with short-term focused investors was not merely psychologically comforting to defenders of corporations and their managements, but also quickly began to resonate in the adjacent communities of financial journalists and more importantly judges, regulators and legislators.

As a result, since the mid-1960’s there has been an intermittent campaign to reign in short-term raiders and, after their advent in the early 2000’s, short-term activists through legal devices to strengthen protections for the board and management. The most notable is the poison pill, but we should not ignore the Williams Act and the SEC regulations implementing it (which are continuing as a focus today in the form of proposed revisions explicitly designed to make activist campaigns more difficult, at least at the margin), state antitakeover statutes, revisions in corporate statutes to empower boards to “just say no” and any number of judicial decisions which, on balance, strengthened the hand of management and the board in contests against short-term activists and corporate raiders.

What Professor Roe’s book does, and does brilliantly, is expose the fallacies in the short-term stock market thesis. Hopefully, it will lead to an abandonment of short-term sloganeering in favor of a more rational and dispassionate examination of the real underlying policy issues, be they of the arrangement of corporate power-sharing between shareholders and managements or of the ways in which corporations can be enlisted in ESG causes of concern to the greater society.

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