Author:Roe, Mark J.

Stock-market-driven short-termism is crippling the American economy, according to legal, judicial, and media analyses. Firms forgo the R&D they need, cut capital spending, and buy back their own stock so feverishly that they starve themselves of cash. The stock market is the primary cause: directors and executives cannot manage for the long term when their shareholders furiously trade their company's stock, they cannot make long-term investments when stockholders demand to see profits on this quarter's financial statements, they cannot even strategize about the long term when shareholder activists demand immediate results, and they cannot keep the cash to invest in their future when stock market pressure drains away that cash in stock buybacks.

This doomsday version of the stock-market-driven short-termism argument entails economy-wide predictions that have not been well-examined for their severity and accuracy. If the scenario is correct and strong, we should first see sharp increases in stock trading in recent decades and more frequent activist interventions, and these increases should be accompanied by (1) sharply declining investment spending in the United States, where large firms depend on stock markets and where activists are important, as compared to advanced economies that do not depend as much on stock markets, (2) buybacks bleeding cash out from the corporate sector, (2) economy-wide R&D spending declining from what it should be, and (4) a stock market unwilling to support innovative, long-term, technological firms. These are the central channels from stock-market-driven short-termism to overall economic degradation. They justify corporate law policies that seek to prevent these outcomes.

But these predicted economy-wide outcomes are either undemonstrated, implausible, or untrue. Corporate R&D is not declining, corporate cash is not bleeding out, and the world's developed nations with neither American-style quarterly oriented stock markets nor aggressive activist investors are investing no more intensely in capital equipment than the United States. The five largest American firms by stock market capitalization are tech-oriented, R&D intensive, longer-term operations. The economy-wide picture is more one of capital markets moving capital from larger, older firms to younger ones; of a post-industrial economy doing more R&D than ever; and of an economy whose investment intensity depends on overall economic activity, not stock market trading nor hedge fund activism. True, the economy-wide data could hide stock market hits that hold back R&D from increasing more and that weaken American capital spending more than is fitting for a post-industrial economy. But if so, these effects have not been shown and several seem implausible. Hence, the calamitous form of the stock-market-driven short-termist argument needs to be reconsidered, recalibrated, and, quite plausibly, rejected.

Then, last, comes the broadest question: why has a view that lacks strong economy-wide evidentiary support become the rare corporate governance issue that attracts attention from the media, political players, policymakers, and the public--and that is widely accepted as true? I suggest why in this paper's final part.

Introduction. 73 I. The Increasingly Short-Term Stock Market and the Theory of Its Deleterious Economic Impact 77 A. The Causes: Activists and Traders 82 B. The Consequences: Slashed Investment, Cash Drained by Buybacks, and Cutbacks in R&D 84 C. Firm-by-Firm Evidence 85 II. Looking for Stock market short-termism's Economy-Wide Impact 87 A. Capital Expenditure Cutbacks around the World 87 B. Buybacks and Borrowings After the Financial Crisis 92 C. R&D Over the Decades 96 D. Does the Stock Market Support R&D-Oriented, Tech-Based Innovation? 98 III. Why Economy-Wide Results Contradict Short-Term Theory 101 A. Even if Pernicious Stock Market Short-Termism Is Prevalent 101 B. With Pernicious Stock Market Short-Termism Not Prevalent: Apple and Occam's Razor 104 C. Limits, Partial Results, and Economy-Wide Fundamentals 106 D. Political and Social Reasons Why, Regardless of Prevalence: Schumpeter v. Polanyi 108 Conclusion 113 Appendix 117 INTRODUCTION

A widely held view among Washington policymakers, the corporate judiciary, corporate executives, the media, and the public is that increasingly frenzied trading in the stock market, coupled with Wall Street's insatiable appetite for immediate profits, starves too many American firms and harms the economy. Jobs are lost and technological progress is stunted, while solutions are so easy to implement that one fumes at their absence.

The World Economic Forum--the Davos people--heard the problem put as sharply as one can imagine: "The finance world's short-termism will destroy our communities, economies and the planet." (1)

The Economist reports that "several grand theories have emerged about what went wrong [with the American economy in the past decade]. Economists fret about secular stagnation, debt hangovers and... demography. [But i]n American boardrooms, meanwhile, a widely held view is that a dangerous short-termism has taken hold." (2)

Leo Strine, one of the nation's leading corporate law judges and thinkers on corporate law, published a major statement of this corporate governance problem last year that sharply criticizes stock market short-termism's impact on American corporations, workers, and savers. (3)

These are hardly isolated attacks. Executives at public companies obsess over their quarterly earnings reports to stockholders, it's said. To keep Wall Street content, executives slash research and development, lay off productive employees, and refuse to invest in factories, equipment, and technology. Each reduction cuts a short-term expense but hurts the firm's future. Executives want to do better but have no choice, because if they slip this quarter, the critics say, stock markets will punish them and their company. Activist vulture investors will circle, challenge executives' authority and, if the executives do not accede, demand their replacement.

Meanwhile, firms with extra cash boost their stock price by buying back their stock instead of investing in their future. Cash that should have boosted productivity escapes from the firm.

Worse, executives at not-yet-targeted firms fear that activists and traders will punish the executives' firms' stock price if the executives go long-term. How can a firm invest for the long term when its owners are transients who may not own any of its stock tomorrow? The economy suffers.

The view is common in corporate, judicial, and academic circles that management must be freed further from investor influence so as to reduce the impact of investors' pernicious short-term, profits-now orientation. These ideas are in the political and corporate lawmaking atmosphere and have captured the imagination of the most important corporate lawmakers in the United States, namely the judges who make corporate law.

Yet, for a view that is so widely shared, the evidence in its favor is sparse. Indeed, the overall, economy-wide evidence--the focus in this Article--fails to support this short-termist view and mostly points to capital markets functioning well enough and not sharply biased against the long-term.

By examining the channels through which stock market short-termism is said to harm the economy, we can better judge the severity of any economy-wide impact. The predicates and consequences of pernicious stock market short-termism should by now be detectable in economy-wide data, if short-termism is deep. First, as a predicate, we should see more frenzied trading and more activist engagements in recent decades. As these two increase, the economy, and large public firms, should spend less on research and development than is ideal and the stock market should shun future-oriented firms. Cash should be draining from the corporate sector as stockholder pressure for more stock buybacks increases. And we should see capital expenditures decreasing rapidly in nations that, like the United States, heavily depend on stock markets and less rapidly in nations less dependent on stock markets.

There's data supporting the short-term theorists' predicates: by important measures trading increased in recent decades and activist engagements have, by any interpretation of the data, increased sharply.

But are the projected consequences present?

Capital investment has indeed decreased in the past decade, but tying the result primarily to stock market short-termism is analytically weak and probably wrong. First, factory-capacity utilization in the United States had not yet, in early 2018, recovered from the 2008-2009 recession. It makes little sense for firms to invest in new capital equipment until they use equipment in place well. Second, if the stock-market-driven story were correct, capital spending trends for the United States and for nations whose corporate sectors are not subject to powerful American-style stock market pressures should differ sharply. Yet, there is no difference: the capital expenditure decline is a developed-nation, worldwide phenomenon, not an American, stock market-based one.

Stock buybacks rose after the 2008-2009 financial crisis; examined alone, one might conclude that cash is indeed bleeding out. But long-term borrowing rose in tandem. Low interest rates pushed corporate America to substitute low-interest debt for stock. Viewed as a capital structure decision, the double trend--more low-interest debt, less equity--fits the short-termist critique poorly. Overall, public firms have more cash, not less.

The economy is not spending less now overall on R&D. Trading may be frenetic, but R&D is not declining. It's hard to see the stock market as resistant to technology, R&D, and a long-term view when America's largest firms are tech-oriented and the newest public firms reach the stock market with weak, and often no, profits, just...

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