Harvard Business Review has warned its readers 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.”
Although short-termism has not produced the predicted deterioration and decline during the decades since, calls to protect corporate leaders from pressures that could induce short-termism have persisted if not intensified. Indeed, such arguments have long been a key reason provided 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’s important that they and others learn to recognize the shortcomings of shorttermism claims.
DOES THE MARKET UNDERESTIMATE LONG-TERM PROJECTS?
A major premise of shorttermism worriers is that markets systematically undervalue long-term investments, which are consequently not fully reflected in stock prices. Although markets do sometimes err, people who express such concern have thus far not provided solid empirical evidence to justify their alarm.
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.
If investors were systematically underestimating longterm prospects, growth companies would tend to trade at discounted levels, enabling their investors to obtain higher returns over the long term. But the empirical evidence indicates that growth stocks actually tend to offer lower returns over the long term — and thus, if anything, tend to trade at elevated levels — compared with stocks whose valuations are grounded in current profitability.
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.
IS HEDGE FUND ACTIVISM DETRIMENTAL?
Short-termism worriers view hedge fund activism as a menace. Consequently, they advocate for measures that would impede it and urge other investors to avoid supporting activists. But that view reflects a flawed assessment of the effects of activism.
Opponents of hedge fund activists argue that they profit by pushing companies to make short-term improvements that come at the expense of long-term prospects and bring about stock price declines down the road.
Supporters of insulation also argue that the shadow of hedge fund intervention has a major adverse effect on the operation of all companies, not just those with which activists actually engage. The desire to reduce the odds of such engagement, it is argued, provides corporate leaders with an incentive to beef up shortterm stock prices by significantly underinvesting in longterm projects. The validity of this view, however, depends on the questionable premise that market prices generally reward reducing investment in long-term projects.
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Furthermore, this view overlooks a significant beneficial effect that the prospect of hedge fund activism should be expected to have on the performance of 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. This mechanism is especially important given the substantial impediments to hostile takeovers permitted by U.S. law. If hedge fund activists were also impeded, managerial slack and underperformance could be expected to increase, to the detriment of investors and the economy.
LONG-TERM AND SHORTTERM INVESTORS: FOES OR ALLIES?
Those who want to protect corporate leaders from market pressures often distinguish between long-term (“good”) investors and short-term (“bad”) investors and view all hedge fund activists, even those who hold positions for a substantial time, as the latter. They urge long-term investors to see the influence of shortterm investors as detrimental.
As Doron Levit and I show in a recent analysis of the interests of short-term and longterm investors, 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 (in, say, index funds) should hardly be uninterested in short-term results. Looking for long-term value does not mean leaning back and counting on managers to ultimately deliver it. Even long-term investors should be keenly interested in interim results, which may signal needed changes in management or governance and incentivize management to focus on shareholders’ interests.
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. 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 shorttermism problems as severe enough to justify insulating managers, there is still significant room for improvement in the governance of public companies in general and decision-making about long-term projects in particular. One beneficial measure would be to tighten the alignment between executive pay and longterm results.
Eliminating short-term incentives and placing substantial limits on corporate leaders’ freedom to unload shares, as Jesse Fried and I advocated in our book, “Pay Without Performance: The Unfulfilled Promise of Executive Compensation,” would significantly increase corporate leaders’ attention to long-term value.
THE FOLLY OF GOING BACK
Insulation advocates essentially seek to reverse the effects of capital market developments over the past several decades that have been largely beneficial. As Adolf Berle and Gardiner Means documented in “The Modern Corporation and Private Property,” the ownership of large U.S. companies used to be dispersed, with owners lacking both the incentives and the ability to monitor performance and intervene. Managers were largely unaccountable and free from investor oversight. To be sure, they felt no pressure to produce short-term results; but they felt no pressure to produce long-term results either.
WARNINGS OF THE perils of short-termism are repeatedly used to argue for shielding managers from outside pressures and oversight. But those warnings are not supported by evidence of the severity of alleged short-termism effects, and they overlook important benefits provided by market and investor oversight. Fears of the short-termism boogeyman 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.
Lucian A. Bebchuk, the James Barr Ames professor of law, economics and finance at Harvard law school and the founding director of its program on Corporate Governance, is the author of “the Myth that insulating boards Serves Long-Term Value” and a co-author of “the Long-Term Effects of Hedge Fund Activism” and “Should Short-Term Shareholders Have Less Rights?”
