Corporate Short-Termism – In the Boardroom and in the Courtroom
Mark J. Roe
Harvard Law School
March 14, 2014
Business Lawyer; Vol 68, August 2013
ECGI - Law Working Paper No. 210
Harvard Public Law Working Paper No. 13-18
A long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying corporate governance and corporate law measures that would further shield managers and boards from shareholder influence, to further free boards and managers to pursue their view of 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 is evidence of short-term stock market distortions, the view is countered by several underanalyzed aspects of the American economy, each of which alone could trump a prescription for more board autonomy. 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 potential short-term problem is largely 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, managerial mechanisms inside the corporation, including compensation packages with a duration that is shorter than typical institutional stock market holdings, and managerial labor markets across firms, including managerial efforts to get good results on their watch, are important sources of short-term distortions; insulating boards from markets further would exacerbate these managerial short-term-favoring mechanisms. 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 unavailable to courts. And, fifth, the widely held view that short-term trading has increased dramatically in recent decades over-interpret, the data; the duration for holdings of many of the country’s major stockholders, such as mutual funds run by 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 support their view further. But these stakeholder considerations can be long-term and they can be short-term. As such, the best view of the evidence is similarly that the pro-stakeholder view must stand or fall on its own. It gains no further evidence-based, conceptual support from a fear of excessive 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.
Number of Pages in PDF File: 30
Keywords: Blockholders, board insulation, bubbles, corporate governance, Delaware, hedge funds, holding duration, investor horizons, long-term value, market efficiency, mergers, myopia, private equity, R&D, short-termism, stakeholder, takeovers, Tobin tax, venture capital
JEL Classification: D21, G3, G18, G28, G30, G34, G38, H73, K4, K20, K22, K42, L21
Date posted: March 27, 2013 ; Last revised: March 15, 2014
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