Abstract
For the short-termism in Chapter 5 to be an issue, it must somehow result in short-termism actions of listed companies. This chapter explores the argument the short-term interests of asset owners and intermediaries are transmitted into listed companies mainly through shareholder activism and executive compensation and the resulting actual or perceived impact of such practices on share prices of listed companies. Consequently, the upstream short-term interests impact the actions of listed companies by causing company managers to forgo longer-term value maximization in favour shorter-term returns.
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- 1.
Roe (2013, 987).
- 2.
- 3.
For example, Trustee Leadership Forum (2016, 1), lists activist hedge funds as a primary driver for short-term behaviour noting that increasing payouts to shareholders is one of their most frequent demands.
- 4.
- 5.
- 6.
Roe (2013, 985).
- 7.
- 8.
- 9.
- 10.
Roe (2013, 985).
- 11.
Nathan (2015).
- 12.
- 13.
- 14.
Roach (2013).
- 15.
See the summary in Garratt and Hamilton (2016, 791), which sets out the many virtues of patient capital—i.e. long-term investors.
- 16.
- 17.
Nathan (2015).
- 18.
Martin (2015).
- 19.
- 20.
See Pozen (2015), where the author lists reasons why institutional investors do not engage, including that they often prefer to hold index funds, participation in proxy contests has high costs which are often not justified on a cost-benefit analysis, and there are concerns about free-riding from other investors.
- 21.
‘Offensive’ activism generally refers to the actions of investors that actively seek out opportunities to invest and pursue strategies aimed at unlocking the value of perceived underperforming listed companies. In contrast, ‘defensive’ activism refers to the activities taken by existing shareholders to pressure management to address the perceived under performance of a listed company.
- 22.
For example, see Strine (2015, 8–11), where Delaware Chief Justice Strine states that “[m]any activist investors hold their stock for a very short period of time … What is even more disturbing than hedge fund turnover is the gerbil-like trading activity of the mutual fund industry….”
- 23.
- 24.
Cremers et al. (2019).
- 25.
For example, a study by Matsumoto (2002), which concluded that firms with a large number of transient investors are more likely to manage earnings in order to meet analyst and investor expectations, and, a study by Francois Brochet, Maria Luomioti and George Serafeim (discussed in Brochet et al. 2012) that analyzed transcripts of earnings calls and found that firms that focus on the short term tend to have a more short-term oriented investor base and that these investors tended to reinforce a short-term focus within the firm.
- 26.
Cremers et al. (2019, 22–23).
- 27.
Ibid., 23.
- 28.
“What Is the Russell 2000 Index.” Online: https://www.investopedia.com/terms/r/russell2000.asp.
- 29.
- 30.
Bebchuk et al. (2015).
- 31.
Ibid., 1154.
- 32.
See the summary in Lipton (2015).
- 33.
- 34.
As noted in Pozen (2015), “an activist with 1% or 2% of a company’s stock has no power to get its reform program adopted unless it can win the support of the institutional investors that own a majority of the company’s stock.”
- 35.
Coffee and Palia (2015, 7), which refers to this recent development of US hedge funds to work in a group in compliance with US securities law to gather small holdings before the ‘wolf pack leader’ files its Schedule 13D.
- 36.
- 37.
Ibid.
- 38.
See Rieg (2015, 197), where the author reviews the literature in this area and concludes that “the interaction of investor myopia and managerial myopia is not straightforward.”
- 39.
SVM was first comprehensively articulated and popularized by Alfred Rappaport in Rappaport (1986) and refined by Rappaport in Rappaport (1998), where Rappaport observed that SVM has gained widespread acceptance in the US and increasing significance in the UK, Europe, Australia and Japan, and is on its way to becoming the global standard for business performance (at 1).
- 40.
- 41.
Rappaport (2011), where Rappaport discussed how US companies in particular have attempted to maximize shareholder value by various means which keep share prices and payments to shareholders high.
- 42.
See Jensen (2010, 32) where Jensen asserts that the modern value maximization proposition has its roots in 200 years of research in economics and finance.
- 43.
Denning (2013).
- 44.
Friedman (1970).
- 45.
The Modern Corporation: Corporate Governance for the 21st Century, Statement on Management. Online: https://themoderncorporation.wordpress.com/management-and-msv/.
- 46.
- 47.
Shapiro (2005).
- 48.
See Rieg (2015, 195).
- 49.
See the description provided in Koller (1994).
- 50.
- 51.
Denning (2014).
- 52.
Rieg (2015, 216–217).
- 53.
Ibid., 195.
- 54.
Rappaport (2011, 49–54).
- 55.
Ibid., 54.
- 56.
Ibid.
- 57.
A criticism levied against SVM by Jack Welch, former-Chairman and CEO of General Electric—see Guerrara (2009).
- 58.
Phillips (2003), where the authors outline what stakeholder theory encompasses, and elaborates on a number of common misconceptions of the theory.
- 59.
For example, see Jensen (2010), where Jensen argues that stakeholder theory is not a complete theory for the objective of a firm as it does not provide a clear purpose thereby requiring the firm to serve many masters, and when there are many masters all end up being short-changed (32–33).
- 60.
Jensen proposed enlightened shareholder value as the objective of a firm, which he says, “uses much of the structure of stakeholder theory but accepts maximization of the long-run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders” (Jenson 2010, 33).
- 61.
Barton (2011, 88).
- 62.
Ibid., 86.
- 63.
UK Companies Act 2006, Chapter 46 (UK Companies Act), Section 172(1).
- 64.
In Delaware which is the domicile for over 50% of US listed companies (http://www.corp.delaware.gov/aboutagency.shtml), Section 141(a) of the Delaware General Corporation Law (Title 8, Chapter 1 of the Delaware Code) provides that the business and affairs of Delaware corporations shall be managed under the direction of a board of directors, and the duties of such board of directors have been developed in case law and require each of the directors to act in good faith to advance the best interests of the corporation (Kaplan v. Centex Corp., 284 A.2d 119, 124 (Del. Ch. 1971)).
- 65.
The UK Companies Act introduced in 2006 clarified in Section 172(1) that a director has a duty to promote the success of the company for the benefit of its members as a whole, and then enumerated further considerations for directors in exercising this duty, including the likely consequences of any long-term decision in the long-term (Section 172(1)(a)), the interests of the company’s employees (Section 172(1)(b)), the need to foster the company’s business relationships (Section 172(1)(c)), and the impact of the company’s operations on the community and the environment (Section 172(1)(d)).
- 66.
See the US decision in Gimbel v. Signal Cos., 316 A.2d 599, 608 (Del. Ch. 1974) and the UK Companies Act 2006, Section 172 and Re Smith & Fawcett Ltd [1942] Ch. 304.
- 67.
Dallas and Barry (2016, 558).
- 68.
See Chapter 3, Sect. B.
- 69.
Bachelder (2014).
- 70.
Kay (2012, 77).
- 71.
Bachelder (2014).
- 72.
Kay (2012, 78).
- 73.
Tonello (2015) referring to the findings in The CEO and Executive Compensation Practices: 2015 Edition, by the Conference Board Inc. and Arthur J. Gallagher & Co.
- 74.
Bettis et al. (2018).
- 75.
Barty and Jones (2012, 16).
- 76.
Dawson (2017).
- 77.
Ibid.
- 78.
Hay Group Report (2014).
- 79.
Ibid.
- 80.
- 81.
Kothuis and Chua (2014, 4).
- 82.
Ibid., 4–5.
- 83.
Ibid.
- 84.
Ibid., 5.
- 85.
Denning (2014).
- 86.
“Equity Vesting Schedules for S&P 1500 CEOs.” 26 April 2013 Equilar. Online: http://www.equilar.com/reports/3-equity-vesting-schedules.html and Dawson (2017).
- 87.
Kay recommended that “[l]ong-term performance incentives should be provided only in the form of company shares to be held at least until after the executive has retired from the business”—Kay (2012, 13).
- 88.
Fisman et al. (2005).
- 89.
Jenter and Lewellen (2017, 1).
- 90.
Ibid.
- 91.
UK Companies Act, Section 303, as amended by The UK Companies (Shareholders’ Rights) Regulations 2009.
- 92.
UK Companies Act, Sections 168 and 312.
- 93.
Ibid., Section 338(3).
- 94.
See §221(d) of the Delaware General Corporation Law which provides that a special meeting “may be called by the board of directors or by such person or persons as may be authorized by the certificate of incorporation or by the bylaws.”
- 95.
See the summary provided in Brown (2014).
- 96.
Delaware General Corporation Law, §141(k).
- 97.
See Fretcher v. Zier, No. CV 12038-VCG, 2017 WL 345142 (Del. Ch. Jan. 24, 2017).
- 98.
See Frankl and Balet (2017), where the authors observe that there were 110 proxy fights in the US in 2016, up 43% from 2012.
- 99.
Investopedia. Online: http://www.investopedia.com/ask/answers/08/how-do-proxy-fights-work.asp.
- 100.
Flaherty (2016).
- 101.
Lee (2016).
- 102.
Coffee and Palia (2015, 7).
- 103.
Ferris (2017).
- 104.
Foley (2017).
- 105.
Global Activism (2016).
- 106.
Ibid.
- 107.
See Chapter 3, Sect. A.
- 108.
- 109.
Easterbrook and Fischel (1981, 1184).
- 110.
A summary of the reasons that company managers are concerned about share prices are set out at http://www.investopedia.com/articles/basics/03/020703.asp. See also Rieg (2015) referencing a study by Mergenthaler et al. (2011), which study provides evidence of the career penalties to company managers for not meeting analyst forecasts (197).
- 111.
Moore and Walker-Arnott (2014, 428).
- 112.
Davies et al. (2014, 17).
- 113.
Vlastelica (2017).
- 114.
See the discussion in Larkin et al. (2017, 4114).
- 115.
Brav et al. (2005).
- 116.
BlackRock’s Fink (2014).
- 117.
Ibid.
- 118.
See Chapter 7, Sect. D.3.b.
- 119.
- 120.
Dallas (2012, 278).
- 121.
Ibid.
- 122.
Ibid.
- 123.
See Chapter 3, Sect. C.
- 124.
Ibid., where Dallas refers to the US Sarbanes-Oxley Act of 2002.
- 125.
Millstein (2005).
- 126.
Moore and Walker-Arnott (2014, 428).
- 127.
Rappaport (2011, 55).
- 128.
Moore and Walker-Arnott (2014, 428).
- 129.
- 130.
Moore and Walker-Arnott (2014, 428).
- 131.
Investopedia. Online: https://www.investopedia.com/terms/g/guidance.asp.
- 132.
Hsieh et al. (2016).
- 133.
Moore and Walker-Arnott (2014, 427).
- 134.
Hsieh et al. (2016).
- 135.
See the evidence presented in Dallas (2012, 279 at Note 80).
- 136.
- 137.
- 138.
Dichev et al. (2016).
- 139.
See Chapter 5, Sect. A.1.
- 140.
Bos et al. (2013).
- 141.
See Chapter 7, Sect. D.
- 142.
See Chapter 2, Sect. C.2.
- 143.
Kay (2012, 11), where Kay asserts that at least in the UK asset managers are the dominant players in the investment chain and in the US, US-registered investment companies managed $13 trillion in assets for more than 92 million US investors at year-end 2012 (Investment Company Institute, 2012 Investment Company Fact Book).
- 144.
Dallas and Barry (2016, 562).
- 145.
- 146.
- 147.
Woolley (2010, 126).
- 148.
Nathan (2015).
- 149.
Ibid.
- 150.
Dallas and Barry (2016, 562).
- 151.
Ibid.
- 152.
Woolley (2010, 127).
- 153.
Dallas and Barry (2016, 562).
- 154.
Kay (2012, 34).
- 155.
Standard asset management fees are generally a small percentage (e.g. 2%) on the asset value, and a larger percentage (e.g. 20%) on the annual performance of the assets (Garratt and Hamilton 2016, 799).
- 156.
Investopedia. Online: http://www.investopedia.com/terms/m/managementfee.asp and Maton (2016).
- 157.
Investopedia. Online: http://www.investopedia.com/terms/p/performance-fee.asp.
- 158.
Garratt and Hamilton (2016, 794), where the authors discuss the self-interest of asset managers and their payment structures which incentivize short-term trading and asset re-allocation activity.
- 159.
See Chapter 2, Sect. C.
- 160.
See Chapter 2, Sect. C.2.
- 161.
Kay (2012, 84).
- 162.
See Chapter 2, Sect. C.2.
- 163.
- 164.
European Union Green Paper (2011, 14).
- 165.
Strine (2015, 24).
- 166.
Tonello (2012).
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Willey, K.M. (2019). Short-Termism Transmission Mechanisms. In: Stock Market Short-Termism. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-22903-0_6
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