A review of Mark Roe’s recent book

Mark Roe, one of the most prominent voices in the short-termism debate, recently wrote an excellent book on “Missing the Target. Why Stock Market Short-Termism Is Not the Problem”. Roe defines short-termism as “overvaluing current corporate results at the expense of future profits and well-being”. The key message of the book is that blaming stock-market short-termism for societal problems is a widely held and politically attractive view, but one that is not supported by the academic evidence. Roe argues that many of those who blame stock markets for being short-termist “miss the target”, as the societal problems they identify are caused by other factors than stock-market short-termism.

Below, I summarize the different chapters of the book and reflect on its contributions to the short-termism debate. Those who are triggered by the views of Mark Roe on the short-termism debate are welcome to attend the (free and hybrid in person/online) workshop of 18 May (6-8 pm), organized by the Jean-Pierre Blumberg Chair, where Mark Roe will discuss the role of external stakeholders in the short-termism debate.

Summary of the book

Chapter 1 of the book describes how the view that the stock market is excessively short-termist is widely held, including by academics, think thanks, business leaders (e.g., Warren Buffett and Jamie Dimon), lawyers (e.g. Martin Lipton), judges (e.g. Leo Strine, Delaware’s former Supreme Court Chief Justice) and politicians (e.g. Hillary Clinton, Joe Biden, Barack Obama, Marco Rubio and Donald Trump). 

Roe summarizes the perceived problem as follows. Investors hold their shares for smaller and smaller periods of time and demand immediate financial returns. This short-term pressure is transmitted to executives through campaigns from hedge fund activists and through executive compensation that is tied to the (short-term) stock price. To please their investors, executives cause corporations to return cash to investors through share buybacks, leaving insufficient funds for long-term investment. This harms the firm’s long-term wellbeing, as well as the broader US economy. In this view, short-termism even contributes to social inequality and environmental damage, as short-termist investors do not support treating workers and the environment well. The policy conclusion is clear: executives should be insulated from short-termist shareholder pressures. 

Roe then analyzes the evidence for the short-termist view and finds it wanting. Chapter 2 of the book reviews the economy-wide evidence of short-termism. Contrary to what the short-termist view would predict, Roe finds that share buybacks have not drained the necessary cash to invest from corporations, as cash outflows were offset by cash inflows from cheap borrowing due to the low interest rates after the financial crisis. In fact, cash piles of corporations have increased. In addition, investments in R&D are increasing (and not decreasing) in the US economy. Admittedly, capital expenditures (another type of long-term investment) have decreased over time, but Roe argues that this reflects technological change. Roe also points out that the decrease in capital expenditure is even more severe in other developed countries, whose economies are less dependent on stock markets than the US and should therefore be less vulnerable to the short-termist pressures that allegedly plague the US economy. Roe concludes that “the predicted economy-wide consequences of a vociferously short-term stock market have not yet been well shown” (p. 45). Roe acknowledges that “it is not easy to show economy-wide effects, because we usually do not know whether alternative arrangements would have made results better” (p. 29), but he argues that the short-termist view has not offered convincing evidence of the alleged harm to the US economy.

In chapters 5-7, Roe reviews the firm-level evidence in favor and against short-termism. Several studies investigate the behavior of firms subject to short-termist pressures. In contrast to studies of the economy-wide effects, it is relatively easier (although still difficult) for firm-level studies to construct a counterfactual and compare firms subject to more short-termist pressures to firms subject to less or no short-termist pressures. Some of the studies even use a natural experiment, which makes a causal inference plausible, something which is (almost) impossible for economy-wide evidence. Although the firm-level evidence is mixed and the number of studies in favor and against the short-termism is roughly the same, Roe argues that the studies finding no short-termism problem are more convincing. For example, a survey of CFOs by Graham, Harvey and Rajgopal, finding that 78% of executives would sacrifice economic value to smooth earnings, is widely cited in support of the short-termism view. However, Roe offers an alternative interpretation of the results: the survey finds that 74% of executives would sacrifice no or only a small amount of economic value, and only 2% of executives would sacrifice a large amount of value. Roe concludes that even if short-termism is a problem, it is clearly not a large one.

In addition, Roe argues that even if the firm-level studies would find that firms make less long-term investments because of short-termist pressures, it does not necessarily follow that the US economy as a whole suffers from a short-termism problem. It may be that other firms, for example privately held firms, pick up the slack left by short-term oriented firms. Roe calls this general equilibrium thinking, in contrast to the partial equilibrium thinking of the short-termist view.

In chapter 3, Roe argues that the short-termism problem is also too often conflated with the problem of externalities. He distinguishes between “type A short-termism”, which is the claim that firms fail to invest sufficiently for the long-term because of short-termist pressures, and “type B short-termism”, which is the claim that short-termist pressures induce corporations to favor corporate profits over the interests of external stakeholders, such as workers or the environment. Roe argues that so-called type B short-termism actually has little to do with short-termism and should rather be considered a problem of corporate selfishness, as corporations fail to internalize negative externalities. As noted by Roe, time horizons are not the problem in that case: “[e]ven firms that think solely in the long-term can and will pollute, degrade the environment, and warm the planet as long as they consider their selfish benefits and not the external social costs” (p. 58).

One may wonder whether it would not be better to adopt the solutions proposed by the advocates of the short-termist view, even if short-termism turns out to be only a small problem for the US economy. Roe also replies to this argument. In chapter 4, he argues that focusing on combatting short-termism risks diverting attention away from better solutions to real societal problems. For example, Roe suggests that there are more effective solutions to societal problems than making corporate governance less short-termist. For example, the growing inequality could be more effectively tackled through (more) progressive income taxation, climate change through a carbon tax, and underinvestment through increased government spending on R&D (which has declined in the US).

In addition, in chapter 8 and 9, Roe analyzes the disadvantages of the proposals of the advocates of the short-termist view. The main policy proposal of these advocates is to insulate executives from financial markets. Roe argues that managerial autonomy can be defended because managers are often better informed than shareholders. However, insulating managers from shareholders also increases agency costs, as the risk of managerial slack and empire building increases. In addition, Roe argues that executives themselves may be the source of short-termist behavior. Executives likely favor good corporate results during their term, as this will help them build their own reputation and may secure them an even better job. Therefore, increasing managerial autonomy comes with a tradeoff. Roe argues in chapter 8 that the short-termism argument should not play a role in how much managerial autonomy is considered optimal.

In chapter 9, Roe analyzes other policy proposals by advocates from the short-termist view, including limiting stock buybacks, eliminating quarterly reporting, heavily taxing short-term trading gains, and giving more voting power to long-term stockholders (so-called loyalty voting rights). Roe argues that none of these proposals are likely to be effective, and that there is no evidence of a short-termism problem anyway. He also points out that these proposals come with their own costs and risk diverting attention from the real issues and solutions. He concludes: “Since we face no deep and pernicious short-termism problem, we shouldn’t pay to try to solve one. If it ain’t broke, don’t fix it” (p. 143).

In the last part of his book, Roe then explores why the short-termist view has become so widely accepted, despite the lack of evidence. In chapter 10 of the book, Roe argues that accelerating technological change is the real culprit in “disrupting the workplace, the large public firm, and the economy overall” (p. 147). The stock market is simply the messenger of this technological change, but it is often confused with it and blamed for its consequences, such as increased employment uncertainty. While the overall technological change may be beneficial, some people may lose out, who may then blame this on stock-market short-termism. 

In chapter 11, Roe argues that blaming stock-market short-termism for societal problems is also intuitively appealing, due to the negative connotations associated with short-termism. The short-termism narrative is then confirmed by its repetition by executives, journalists and policymakers.   

Chapter 12 identifies the interest groups that benefit from the short-termism narrative. In the first place, executives benefit because the policy conclusion is that they should be insulated from shareholders. The short-termism narrative provides a non-selfish justification for them to pursue their self-interest. Secondly, employees also benefit from policies that slow technological changes that could endanger their jobs. 

Roe argues in chapter 13 that politicians also like the short-termist narrative, because this narrative allows them to criticize Wall Street, which is disliked in the public opinion, without attacking the foundations of capitalism itself and risk being accused of socialism. Short-termist stock markets are a useful scapegoat for politicians who want to appeal to those negatively impacted by disruptive technological changes.

Roe concludes: “what underlies much of the public controversy is not so much disagreement over the actual evidence but social conflict due to social disruption. The short-termism controversy in public rhetoric is a rejection of the stock market not so much for its time horizon but because of widespread economic anxiety. And that underlying conflict will not soon abate.” (p. 175)

Reflections on the short-termism debate

The most important contribution of Roe’s book is that it takes a clear position in the short-termism debate on the basis of a comprehensive overview of the evidence of short-termism. Many other commentators have taken positions in this debate, but not always with a similar attention for the academic evidence. In addition, many academics have analyzed parts of the short-termism debate, focusing on shareholder activism, loyalty voting rights, share buybacks, quarterly reporting, or the short-term focus of institutional investors, for example. Roe has brought the insights of these studies together and has analyzed their policy implications. 

In this regard, Roe’s book is most similar to Kim Willey’s 2019 book on “Stock Market Short-Termism. Law, Regulation and Reform”. Willey develops a similar model of how short-termism is supposed to originate and be transmitted to managers. However, Willey interprets the empirical evidence differently and reaches the opposite policy conclusion as Roe: she argues that reforms are necessary to combat short-termism, although she favors a “light-touch” approach, relying mainly on disclosures and regulations of which corporations can opt out. Roe’s book therefore adds to the debate by taking the view that short-termism is not a problem, focusing more on the (lack of) economy-wide evidence on the impact of short-termism.

One limit of Roe’s book is that it focuses on short-termism in the US and does not offer evidence on short-termism in other jurisdictions, such as the EU. Such a limit to the scope is well-justified to keep the analysis tractable, but it does mean that there is room for future research on short-termism in European corporate governance. This is exactly the research that we are doing at the moment with the Jean-Pierre Blumberg Chair (see here for an earlier blogpost about the research of the Jean-Pierre Blumberg Chair and here for my opening lecture for the Jean-Pierre Blumberg Chair).

I argue that there are several reasons to believe that investor-driven short-termism may be even less likely to pose a problem in Europe. Firstly, in continental European, countries more often have a controlling shareholder than corporations in the US.^[1] Corporations with a controlling shareholder will face less pressure from shareholder activists, as it is unlikely that activists will win a vote in the general meeting against a controlling shareholder. Controlling shareholders are also said to have a longer time horizon, because they derive private benefits from remaining in control of the corporation.^[2] This may be especially true for family ownership, due to a desire to transfer the family business to the next generation.^[3]

Secondly, executive compensation is less likely to transmit short-termism from the stock market to managers in Europe, because compensation is less often based on the stock price. Share grants and stock options make up a smaller portion of executive compensation in continental Europe than in the US, in favor of more fixed pay.^[4]

Thirdly, shareholder activism is much rarer in continental European corporate governance than in the US.^[5] This implies that the argument that shareholder activists are the cause of short-termism carries much less weight for continental European jurisdictions. However, this conclusion may soon change, as European shareholder activism seems to be on the rise recently.

In conclusion, there are reasons to believe that stock-market short-termism is even less likely to be present in Europe than in the US. However, to my knowledge, no studies have comprehensively analyzed short-termism in continental European corporate governance and there has been little empirical evidence on the impact of corporate governance on short-termism in Europe that could confirm these hypotheses. Further research on whether short-termism actually constitutes a problem in Europe would therefore be particularly welcome. Roe’s book does not solve this gap in the literature, but its careful and comprehensive analysis of the short-termism problem provides a useful starting point, not in the least because of its analysis of why the short-termism view has been so successful politically, despite the lack of empirical evidence.

Mark Roe will be a guest lecturer during the workshop of 18 May (6-8 pm) on the role of external stakeholders in the short-termism debate, organized by the Jean-Pierre Blumberg Chair at the University of Antwerp. Registration is free and both in-person and hybrid attendance are possible. The workshop is accredited by the OVB, IBJ and FSMA. Registration via this link.

---

^[1] G. AMINADAV and E. PAPAIOANNOU, “Corporate Control around the World”, Journal of Finance 2020, (1191) 1205.

^[2] A.H. CHOI, “Concentrated ownership and long-term shareholder value”, Harvard Business Law Review 2018, 53-99.

^[3] See, for example: H.S. JAMES, “Owner as Manager, Extended Horizons and the Family Firm”, International Journal of the Economics of Business 1999, 41-55; I. LE BRETON-MILLER and D. MILLER, “Why Do Some Family Businesses Out–Compete? Governance, Long–Term Orientations, and Sustainable Capability”, Entrepreneurship Theory and Practice 2006, (731) 734.

^[4] EDMANS, A., GABAIX, X. and JENTER, D., “Executive Compensation: A Survey of Theory and Evidence”, ECGI Finance Working Paper nr. 524/2017, July 2017, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2992287, 167.

^[5] M. BECHT, J. FRANKS, J. GRANT, and H.F. WAGNER, “Returns to Hedge Fund Activism: An International Study”, Review of Financial Studies 2017, 2933-2971.