INTRODUCTION I. SHORT-TERM VERSUS LONG-TERM SHAREHOLDERS: THE CONVENTION VIEW A. The (Undesirable) Interests of Short-Term Shareholders B. The (Desirable) Interests of Long-Term Shareholders C. Policy Proposals To Favor Long-Term Shareholders 1. Enhanced Voting and Control Rights 2. "Loyalty" Shares and Dividends 3. Tilting the Tax System To Favor Long-Term Shareholders 4. Summing Up II. ANALYTICAL BUILDING BLOCKS A. Policy Goal: Maximizing Economic Value B. Shareholders' Objectives III. LONG-TERM SHAREHOLDER RETURNS IN A NON-TRANSACTING FIRM A. Framework of Analysis B. Long-Term Shareholders' "Better" Interests 1. Short-Term Shareholders 2. Long-Term Shareholders IV. LONG-TERM SHAREHOLDER RETURNS IN A REPURCHASING FIRM A. The Widespread Use of Repurchases B. Analytical Framework: Decoupling Effect of Share Repurchases C. Bargain Repurchases 1. Economic Logic 2. Evidence of Bargain Repurchases a. What Executives Say and Do b. Post-Repurchase Stock Returns V. DESTROYING VALUE IN A REPURCHASING FIRM TO BOOST LONG-TERM SHAREHOLDER RETURNS A. Costly Contraction 1. How Inefficient Capital Allocation Can Benefit Long-Term Shareholders 2. Must Economic Value Be Sacrificed To Engage in Bargain Repurchases? B. Costly Price-Depressing Manipulation Around Bargain Repurchases VI. LONG-TERM SHAREHOLDER RETURNS IN AN ISSUING FIRM A. Widespread Use of Equity Issuances 1. Acquisition-Related Issuances 2. Seasoned Equity Offerings a. Firm-Commitment SEOs b. At-The-Market Offerings B. Analytical Framework: Decoupling Effect of Equity Issuances C. Inflated-Price Issuances 1. Economic Logic 2. Evidence of Inflated-Price Issuances VII. DESTROYING VALUE IN AN ISSUING FIRM TO BOOST LONG-TERM SHAREHOLDER RETURNS A. Costly Expansion 1. Economic Logic 2. AOL-Time Warner Transaction 3. Must Value Be Destroyed To Issue Overpriced Equity? B. Costly Price-Boosting Manipulation Around Inflated-Price Equity Issuances 1. Economic Logic 2. Evidence of Costly Price-Boosting Manipulation Around Equity Issuances VIII. WHEN IS FAVORING LONG-TERM SHAREHOLDERS UNDESIRABLE? A. Volume of Repurchases and Equity Issuances 1. Can Rarely Transacting Firms Be Identified Ex Ante? 2. Should Firms Be Prohibited from Transacting in Their Own Shares? B. Managers' Ability To Exploit Information Asymmetry via the Firm C. The Difficulty of Engaging in Costly Price Manipulation IX. FURTHER CONSIDERATIONS IN ASSESSING THE DESIRABILITY OF FAVORING LONG-TERM SHAREHOLDERS A. Non-Shareholders as Residual Claimants B. Managerial Agency Costs C. It's Still an Uneasy Case CONCLUSION INTRODUCTION
This Article questions a persistent and pervasive view about the proper objective of corporate governance: that managers should favor long-term shareholders over short-term shareholders and aim to increase long-term shareholder value rather than the short-term stock price. This view is widely shared by leading academics, executives, corporate lawyers, and judges. (1) It is also at the heart of recent reform proposals--in the United States, the United Kingdom, and elsewhere--to give long-term shareholders more power over public companies. (2)
The persistence of this view derives from a widely held and appealing intuition: because managers serving short-term shareholders may destroy economic value to boost the short-term stock price, managers serving long-term shareholders will necessarily generate more economic value over time (a bigger "pie"). The problem with this intuition is that it is wrong, at least for the typical U.S. firm that transacts in (buys and sells) a large volume of its own shares. (3) Yes, managers serving short-term shareholders might destroy economic value to boost the short-term stock price. But in a transacting firm, managers serving long-term shareholders might also destroy economic value to boost the long-term stock price. In fact, long-term shareholders may well benefit more from value destruction than will short-term shareholders. Therefore, favoring long-term shareholders in the typical firm could, paradoxically, reduce the size of the pie created by the firm over time.
A firm's directors and CEO (collectively, its "managers") have at least some incentive to serve shareholders' interests, even if they are not completely faithful agents of the firm's shareholders. How managers respond to this incentive will depend, in part, on shareholders' time horizons. If short-term investors exert greater influence on managers than do long-term shareholders, then managers can be expected to focus on increasing the short-term stock price rather than long-term shareholder value. If long-term shareholders are more powerful than short-term shareholders, then managers can be expected to focus less on the short-term stock price and more on increasing long-term shareholder returns. (4)
Much attention has been focused on the potential problems that can arise when a firm's investor base consists largely of short-term shareholders. (5) In particular, managers seeking to serve short-term shareholders may engage in "short-termism": taking steps that boost the short-term stock price but reduce the economic value created by the firm over the long term. The cost of short-termism is borne by other parties, including long-term shareholders (if any) and future shareholders who purchase shares in the short term. (6)
Short-termism has long been considered a major problem for publicly traded U.S. firms. For decades, legal academics, (7) business school professors, (8) executives, (9) 10 and corporate lawyers (10) have decried the potentially perverse interests of short-term shareholders. The recent financial crisis, which many blame on the influence of short-term shareholders, has renewed and intensified criticism of these investors. (11)
While short-term shareholder interests are roundly criticized, the interests of long-term shareholders are generally all but put on a pedestal. Legal academics (12) and business school professors (13) urge managers to ignore the short term stock price and focus on maximizing value for long-term shareholders. (14) Henry Hansmann and Reinier Kraakman have gone so far as to say a decade ago that "[t]here is no longer any serious competitor to the view that corporate law should principally strive to increase long-term shareholder value. (15) Managers, in turn, appear to have accepted the norm of maximizing long-term shareholder value. (16)
However, even managers who wish to serve long-term shareholders may believe that short-term shareholder pressure prevents them from doing so. Consequently, policymakers are considering various types of proposals to increase the power of long-term shareholders in public companies relative to the power of short-term shareholders. (17) One set of proposals aims to give long-term shareholders more voting rights in the firm. (18) Another set of proposals seeks to increase the number of long-term shareholders by rewarding them with additional dividends or other cash-flow rights. (19) A third set of proposals seeks to increase the number of long-term shareholders by revamping the income tax system to make long-term stock ownership relatively more attractive. (20)
Yet the norm of favoring long-term shareholders over short-term shareholders, and efforts to boost the number and power of long-term shareholders in public companies, are driven by a flawed intuition: that managers serving long-term shareholders will necessarily generate more value over time than managers serving short-term stockholders. I show that in a typical U.S. firm--that is, a firm that transacts heavily in its own shares--managers serving long-term shareholders will not necessarily generate more value over time than managers serving short-term shareholders, and may well generate less. All of the recent efforts to favor long-term shareholders may thus, perversely, reduce the value generated by firms over the long term. (21)
For most of this Article, I focus on a firm in which the only residual claimants on the value created by the firm are the firm's current and future share holders: the investors who own or will own shares between now and "the long term" (by which I mean the relevant end period, however that period is determined). In other words, the firm's current and future shareholders capture all of the value generated by the firm over time. I will call this a "shareholder-only" firm.
I begin by considering a "non-transacting" shareholder-only firm: one that does not repurchase its own shares or issue additional shares before the long term arrives. I show that, in this type of firm, the conventional view is correct: managers serving long-term shareholders will generate more economic value over time than managers serving short-term shareholders. In particular, long-term shareholders will want managers to maximize the economic pie. Short-term shareholders, on the other hand, may benefit when managers engage in what I call "costly price-boosting manipulation"--actions that boost the short-term stock price at the expense of the pie generated over the long term. Therefore, in such a firm, it is better for the economy, and for investors in the aggregate, if managers seek to maximize long-term shareholder value instead of doing all they can to boost the short-term stock price, regardless of the consequences for the size of the pie.
Most U.S. firms, however, are "transacting." They buy and sell large volumes of their own shares each year: approximately $1 trillion worth marketwide. (22) The magnitude is staggering, not only in absolute terms, but also relative to firms' market capitalization. Over any given five-year period, U.S. firms buy and sell stock equivalent in value to approximately 30% of their aggregate market capitalization. (23) Thus, for example, a company with a market capitalization of $10 billion today can be expected to buy and sell $3 billion of its own shares over the next five years.
I show that, in a transacting firm, managers can...