Short-termism in European corporate governance

Conference organized by University of Antwerp, Harvard Law School and ECGI on 30 May

Short-termist behavior by corporations is often seen as a large societal problem. For example, Joe Biden wrote in a 2016 op-ed for the Wall Street Journal: “Short-termism […] is one of the greatest threats to America’s enduring prosperity”. 

However, the debate on short-termism has so far largely focused on possible short-termism in the US and the UK). Short-termism in European corporate governance has received much less attention. A notable exception is the 2020 EY study for the European Commission on “directors’ duties and sustainable corporate governance. This study is generally regarded as heavily flawed, however.

For this reason, the University of Antwerp, Harvard Law School and the European Corporate Governance Institute (ECGI) have decided to organize a conference on “short-termism in European corporate governance” on 30 May in Antwerp. We believe that it is important to study short-termism in (continental) Europe, because corporate governance in continental Europe differs in important respects from corporate governance in the US and the UK, with potentially profound implications for the short-termism debate. 

Controlling shareholders in Europe

A first important difference is that corporations in continental European countries more often have a controlling shareholder than corporations in the US and the UK. For example, according to one paper, the percentage of shares held by the largest shareholder in the corporation is much higher in France (46.4%), Germany (45.3%), Belgium (38.6%) and the Netherlands (34.6%), than in the US (21.4%) and the UK (19.5%). 

This is relevant, because controlling can have an important impact on short-termism, as I argue in a recent working paper. If corporate short-termism is caused by short-termist institutional investors pressuring managers for short-term results, controlling shareholders will block the transmission of this short-termism. In addition, if short-termist managers are causing corporate short-termism, controlling shareholders have the incentives and the power to monitor these short-termist managers, and cause them to be more long-term oriented.  

Whether controlling shareholders have a positive or negative impact on a corporation’s long-term orientation will depend on the circumstances, and particularly on the type of controlling shareholders. On the one hand, controlling shareholders have stronger incentives to think in the long term than other shareholders, due to the size and illiquidity of their participation, which exposes them to a larger extent to the long-term cash flows of the corporation. On the other hand, controlling shareholders may also enjoy private benefits of control. Because some private benefits of control are not easily transferred, controlling shareholders may be “locked in” and forced to think of the long-term future of the corporation. However, private benefits of control may also incentivize controlling shareholders to act in a short-termist manner. For example, a family controlling shareholder may prioritize its short-term liquidity needs over the long-term investments needed by the corporation.

Executive compensation structure in Europe

A second notable difference of European corporate governance is the structure of executive compensation. Share grants and stock options make up a smaller portion of executive compensation in continental Europe than in the US and the UK, and a higher portion of total pay is fixed instead of variable in Europe, according to research.

What executive compensation structure is optimal can be debated. However, variable pay can incentivize short-termism if it is based on short-term targets, and even targets in long-term incentive plans become short-term targets over time. In addition, if executives can sell the shares and stock options that they have been awarded as part of their compensation, they can benefit from short-term bumps to the stock price, while avoiding the long-term stock price reversal. There is some empirical evidence in the US that short-term incentives in executive compensation, in particular in the form of shares and stock options that can be sold in the short-term, indeed leads to short-term focused corporate behavior, such as cuts to investment (Edmans, Fang and Lewellen, 2017; Ladika and Sautner, 2020; Edmans, Fang and Huang, 2021). 

Because executive compensation is generally structured differently in Europe than in the US and the UK, it is important to study short-termism as well from a European perspective.

Shareholder activism and engagement in Europe

Third, continental European corporate governance is also different from the UK and the US because shareholder activism and shareholder engagement play a much smaller role. Studies report that the number of activist engagements per the number of listed firms is smaller in European countries like Belgium and France than the US and the UK. 

While several authors have argued that shareholder activists are excessively focused on the short term and pressure the management of a corporation to take short-termist actions, others have argued that shareholder activism boosts long-term firm performance. However, because shareholder activism is much less common in Europe, the argument that short-termism is caused by shareholder activists carries much less weight in Europe. In addition, shareholder engagement in Europe is often less confrontational than in the US. 

These differences justify studying the impact of shareholder activism on short-termism in the European context as well.

Loyalty voting rights in Europe

European legislators have also adopted governance reforms with the goal of combatting short-termism. The most popular reform has been to allow corporations to grant “loyalty voting rights” to shareholders: multiple voting rights for “loyal” shareholders who have held their shares for more than a specified time period. Such loyalty voting rights are allowed in Belgium, France, the Netherlands, Italy and Spain (among other jurisdictions). 

The idea behind allowing loyalty voting rights is that it encourages shareholders (and therefore indirectly corporations) to think in the long term. However, in practice loyalty voting rights seem to be mostly used by controlling shareholders to strengthen their control (or retain their control when selling shares or not participating in new share issuances). Practical barriers make loyalty voting rights de facto unavailable for long-term institutional investors. Whether loyalty voting rights are helpful or not for combatting short-termism therefore depends on whether you believe controlling shareholders generally are more long-term oriented or not. 

This debate on loyalty voting rights in Europe also justifies studying short-termism in the European context.

Conclusion

These topics, and many others, will be addressed more comprehensively by our speakers and discussants during the conference on “short-termism in European corporate governance” on 30 May in Antwerp. Registration is still possible and is free for academics and students (€100 for practitioners). Participants can attend online or in person in Antwerp. The program and more information can be found here.

Tom Vos
Visiting professor at the Jean-Pierre Blumberg Chair
at the University of Antwerp
Associate at Linklaters Belgium
Voluntary scientific collaborator at the KU Leuven

Schrijf nu in voor de ‘disputatio‘
op donderdag 1 juni 2023 te Leuven