Stock Market Short-Termism

Law, Regulation, and Reform

Kim M. Willey

• Publisher: Palgrave Macmillan
• Year: 2019
• ISBN:
  9783030229030
• Topic: Business
• Subtopic: Finance
• Index: Business

Consideration of harmful short-termism in capital markets is prevalent amongst legal and business academics. It is also garnering increased attention in corporate board rooms and executive suites, and from the investing public. As a result, correcting perceived short-termism in capital markets has become a rationale for reform used by regulators across the globe. Despite the considerable attention given to this phenomenon, there has not yet been a comprehensive book analyzing the perceived short-termism problem, its sources and causes, and reform efforts undertaken to date. This book fills this gap by documenting the rise of the short-termism discussion, analyzing the significance of the problem, and considering the proposed legal remedies. Based on this analysis, a framework for effective short-termism reform is offered.

© The Author(s) 2019

Kim M. WilleyStock Market Short-Termismhttps://doi.org/10.1007/978-3-030-22903-0_1

Begin Abstract

1. Introduction

Kim M. Willey¹

(1)

Faculty of Law, University of Victoria, Victoria, BC, Canada

Kim M. Willey

End Abstract

The role of modern companies, and, more precisely, the functioning of the world’s largest publicly listed companies, has been cast into the spotlight after the global financial crisis of 2007–2009 (GFC).¹ Central to this conversation is the proposition that listed companies and their financial intermediaries and investors are far too focused on short-term financial objectives, and corrective measures are urgently needed. This short-term financial focus hinders the development of sustainable long-term oriented listed companies that create employment, further stakeholder interests, develop valuable products and services, generate earnings, and return profits to shareholders. It has been widely asserted that such short-termism was a contributing factor in the GFC, and continues to jeopardize the operations of listed companies, and consequently erode the long-term growth potential of modern markets. Alarming claims have been made that short-termism in stock markets is increasing drastically, and the “destructive impact of short-termism has reached crisis proportions”,² and that “[t]he ongoing short-termism in the business world is undermining corporate investment, holding back economic growth, and lowering returns for savers.”³ This book provides a comprehensive review of the causes and effects of stock market short-termism (SMST) and offers a tangible framework for reform.

1 A. Rationale for This Book

The research in this book has been undertaken primarily as a result of the countless calls for regulatory and financial industry reform to address SMST , and the resulting need to analyze whether implemented reforms conceptually address such concerns. Demonstrating that allegations of short-termism in financial markets have increased significantly since the GFC, Fig. 1 illustrates the increased use of the term ‘short-termism’ in major international business papers from 1999 to 2018. As illustrated by the results of each of the Wall Street Journal and the narrowed definition searches in Fig. 1, the use of the term short-termism has followed a steady upward trend.

Fig. 1

Citations of the term ‘short-termism’

(Source Compiled from data available on Factiva as at 31 December 2018)

This book explores the extent to which this increased attention to the SMST problem involving public companies has generated reforms by regulators and the financial industry. Jurisdiction-specific academic analysis of short-termism has been previously conducted, particularly in the United States (US), the United Kingdom (UK) and the European Union (EU).⁴ However, to date there has not been a comprehensive academic analysis of all implemented—or seriously considered—short-termism reform efforts. This broader analysis is warranted because, as discussed further in Chapter 3, short-termism concerns are raised in markets around the world and modern capital markets are increasingly interconnected. This interconnectedness, which was highlighted by the GFC,⁵ has the potential to further the globalization of issues such short-termism.

Although ‘western’ stock markets, specifically the US and the UK, have been the primary focus of the discussion,⁶ capital market short-termism has been discussed by policymakers outside the US and the UK, notably in the EU. As an example, commenting on the Swedish capital market, Sophie Nachemson-Ekwall of the Stockholm School of Economics, discusses how after years of high taxes, family ownership has been falling, and with domestic institutional investors continuing to act in a markedly passive manner, the opportunities for private equity, foreign industrial owners and foreign—passive and short-term—institutional investors have grown.⁷ According to Nachemson-Ekwall, this trend has resulted in the Swedish capital market generally having features associated with ‘value-destructive short-termism’.⁸

Short-termism may not presently be a significant concern outside the Anglo-American capital market model. However, it is, and arguably should be, of interest globally. Equity market interconnectivity facilitated primarily by US investors diversifying risk and looking for high growth by seeking investment opportunities outside of their home jurisdictions⁹ could further issues of short-termism.¹⁰ Relevant to the short-termism discussion is foreign portfolio investment (FPI), rather than foreign direct investment (FDI). FPI is defined by the European Commission (EC) as where “an investor buys equity in or debt of a foreign company <but> [t]he investor does not necessarily have a long-term interest in the company or an influence over its management.”¹¹ Unlike FDI, which involves buying a controlling interest in a business,¹² FPI is highly liquid and passive—i.e. in the equity context, the investment is generally under 10% of the voting rights.¹³ Despite declines in FPI in 2008 due to the GFC and 2015 due to global political uncertainty, FPI is generally following an upward trend,¹⁴ which is particularly evident in the Euro-area.¹⁵ Therefore, policymakers outside of the US and the UK are, and should continue to be, alive to the issue of short-termism, and there is merit in a global analysis whereby regulators and the financial industry can learn from what is being done outside their respective jurisdictions.

There are undoubtedly differences in financial markets around the globe, particularly with respect to operating cultures and regulatory frameworks. As a result, any definitive reform efforts will need to be tailored to the relevant implementing jurisdiction. Illustrating these differences, Anglo-American corporate governance systems, such as the US, UK, Canada and Australia, are seen to have a similar approach based on prioritizing shareholder value, often with a dispersed shareholder base.¹⁶ In contrast, in the EU—excluding the UK—a greater reliance generally on bank lending and debt, rather than equity, has been identified.¹⁷ Also, in the EU, listed companies have traditionally not been widely-held as share ownership has been concentrated in a limited number of resident shareholders, such as, for example, family groups or the state.¹⁸

In Asia, concentrated ownership of listed companies is also a common feature.¹⁹ For example, the Chinese government holds a significant portion of the equity of Chinese listed companies, and approximately 75% of Hong Kong listed companies have a dominant shareholder.²⁰ However, many listed companies appear to be moving towards an Anglo-American ...

Table of contents

• Cover
• Front Matter
• 1. Introduction
• 2. Defining the Issues
• 3. Short-Termism, an Evolving Concern?
• 4. What Has Been Done to Correct Short-Termism?
• 5. Is There a Short-Termism Problem at All?
• 6. Short-Termism Transmission Mechanisms
• 7. What Are the Harms of Short-Termism?
• 8. Dual Pathway for Short-Termism Reform
• 9. Conclusion
• Back Matter