A Bird in the Hand: An Existence Argument for Short-Term Gains that Harm Long-Term Value and Its Implications for Corporate Law
11 Pages Posted: 20 Feb 2019 Last revised: 5 Apr 2019
Date Written: February 9, 2019
Commentators (including this one) have long have been skeptical that shareholders would choose short-term gains at the expense of long-term value creation. What this skepticism has missed, however, is the distinction between short-term gains in the hands of shareholders from asset distributions (dividends and share repurchases or spin offs) plus remaining share value compared to share value alone. When shareholders can remove assets from the firm in the form of dividends, share repurchases, or spinoffs, they can often do so at the expense of creditors and do better from the combination of removed assets and remaining share value than from holding shares alone. This implies a crucial difference between two seemingly-similar statements of corporate law: (1) there is a duty to "maximize the long run interests of shareholders" which could involve removing assets from the corporation and putting them in the hands of shareholders along with the remaining equity value of the firm, and (2) there is a duty to "maximize the value of the corporation for the benefit of its shareholders" which might place off limits the distribution of asset value that reduced the value of the stock-market capitalization. Consistent with corporate law, it seems most appropriate to view the duty as akin to maximizing the value of an account at the corporation. The duty is to maximize the value of the corporation, from which derives the value of the equity. Any other rule does a disservice to the fundamental idea of limited liability: creditors are paid before shareholders, and in return shareholders are not liable for corporate debts. Since the types of asset distributions that make short-term gains possible at the expense of the long term would not be possible if debt had to be repaid first in full, the duty to maximize the long-run interests of shareholders should not include any duty to distribute assets to them before other obligations are first repaid.
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