In a memorandum issued by the law firm of Wachtell, Lipton, Rosen & Katz (Wachtell) last week, Do Activist Hedge Funds Really Create Long Term Value?, the firm’s founding partner Martin Lipton and another senior partner of the law firm criticize again my empirical study with Alon Brav and Wei Jiang, The Long-Term Effects of Hedge Fund Activism. The memorandum announces triumphantly that Wachtell is not alone in its opposition to our study and that two staff members from the Institute for Governance of Private and Public Organizations (IGOPP) in Montreal issued a white paper (available here) criticizing our study. Wachtell asserts that the IGOPP paper provides a “refutation” of our findings that is “academically rigorous.” An examination of this paper, however, indicates that it is anything but academically rigorous, and that the Wachtell memo is yet another attempt by the law firm to run away from empirical evidence that is inconsistent with its long-standing claims.
Posts Tagged ‘Short-termism’
About a year ago, Professor Lucian Bebchuk took to the pages of the Wall Street Journal to declare that he had conducted a study that he claimed proved that activist hedge funds are good for companies and the economy. Not being statisticians or econometricians, we did not respond by trying to conduct a study proving the opposite. Instead, we pointed out some of the more obvious methodological flaws in Professor Bebchuk’s study, as well as some observations from our years of real-world experience that lead us to believe that the short-term influence of activist hedge funds has been, and continues to be, profoundly destructive to the long-term health of companies and the American economy.
Are private firms more efficient than public firms? Jensen (1986) suggests that going-private could result in efficiency gains by aligning managers’ incentives with shareholders and providing better monitoring. In our paper, Do Going-Private Transactions Affect Plant Efficiency and Investment?, forthcoming in the Review of Financial Studies, we examine a broad dataset of going-private transactions, including those taken private by private equity, management and private operating firms between 1981 and 2005. We link data on going-private transactions to rich plant-level US Census microdata to examine how going-private affects plant-level productivity, investment, and exit (sale and closure). While we find within-plant increases in measures of productivity after going-private, there is little evidence of efficiency gains relative to a control sample composed of firms from within the same industry, and of similar age and size (employment) as the going-private firms. Further, our productivity results hold excluding all plants that underwent a change in ownership after going-private, alleviating the potential concern that control plants may undergo improvements through ownership changes.
The protest against short termism in corporate America is rising. Business and political leaders are decrying the emphasis on quarterly results—which they claim is preventing corporations from making long-term investments needed for sustainable growth.
However, these critics of short termism have a skewed view of the facts and there are logical flaws in their arguments. Moreover, their proposals would dramatically cut back on shareholder rights to hold companies accountable.
The critics of short termism stress how much the average daily share volume has increased over the last few decades. Although this is factually correct, this sharp average increase is caused primarily by a tremendous rise in intraday trading.
Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law
Leo Strine, Chief Justice of the Delaware Supreme Court Review and a Senior Fellow of the Harvard Law School Program on Corporate Governance, recently published in the Columbia Law Review a response essay to an essay by Professor Lucian Bebchuk published in the Columbia Law Review several months earlier. Professor Bebchuk’s essay, The Myth that Insulating Boards Serves Long-Term Value, is available here and was featured on the Forum here. Chief Justice Strine’s essay, titled Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law, is available here.
The abstract of Chief Justice Strine’s essay summarizes it briefly as follows:
Two articles (among several) in a comprehensive proposal to revise EU corporate governance would have a significant beneficial impact if they were to be adopted in the United States. In large measure they mirror recommendations by Chief Justice Leo E. Strine, Jr., in two essays: Can We do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law, 114 Columbia Law Review 449 (Mar. 2014) and One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term? 66 Business Lawyer 1 (Nov. 2010).
We published this post last August. Since then there have been several developments that prompt us to revisit it; adding the first three paragraphs below.
First, Delaware Supreme Court Chief Justice Leo E. Strine, Jr. published a brilliant article in the Columbia Law Review, Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law in which he points out the serious defects in allowing short-term investors to override carefully considered judgments of the boards of directors of public corporations. Chief Justice Strine rejects the argument of the academic activists and activist hedge funds that shareholders should have the unfettered right to force corporations to maximize shareholder value in the short run. We embrace Chief Justice Strine’s reasoning and conclusions.
Excessive risk-taking by financial institutions and overly generous executive pay are widely regarded as key factors in the 2007-09 crisis. In particular, it has become commonplace to blame banks and securities companies for compensation packages that reward managers (and more generally, other risk-takers such as traders and salesmen) generously for making investments with high returns in the short run but large risks that emerge only in the long run. As governments have been forced to rescue failing financial institutions, politicians and the media have stressed the need to cut executive pay packages and rein in incentives based on options and bonuses, making them more dependent on long-term performance and in extreme cases eliminating them outright. It is natural to ask whether this is the right policy response to the problem. It is crucial to ask what is the root of the problem—that is, precisely which market failure produced excessive risk-taking.
The recent announcement of the formation of the Shareholder-Director Exchange, a new group that aims to facilitate direct communication between institutional shareholders (namely, mutual funds and pension programs) and non-management directors of the U.S. public companies they own, has been accompanied by a flurry of articles regarding the purposes and possibilities of this new group. From my perspective, the Shareholder-Director Exchange has tremendous potential to help improve corporate governance and performance in this country.
In our paper, The Real Costs of Disclosure, which was recently made publicly available on SSRN, we analyze the effect of a firm’s disclosure policy on real investment. An extensive literature highlights numerous benefits of disclosure. Diamond (1985) shows that disclosing information reduces the need for each individual shareholder to bear the cost of gathering it. In Diamond and Verrecchia (1991), disclosure reduces the cost of capital by lowering the information asymmetry that shareholders suffer if they subsequently need to sell due to a liquidity shock. Kanodia (1980) and Fishman and Hagerty (1989) show that disclosure increases price efficiency and thus the manager’s investment incentives.
However, the costs of disclosure have been more difficult to pin down. Standard models (e.g. Verrecchia (1983)) typically assume an exogenous cost of disclosure, justified by several motivations. First, the actual act of communicating information may be costly. While such costs were likely significant at the time of writing, when information had to be mailed to shareholders, nowadays these costs are likely much smaller due to electronic communication. Second, there may be costs of producing information. However, firms already produce copious information for internal or tax purposes. Third, the information may be proprietary (i.e., business sensitive) and disclosing it will benefit competitors (e.g., Verrecchia (1983) and Dye (1986)). However, while likely important for some types of disclosure (e.g., the stage of a patent application), proprietary considerations are unlikely to be for others (e.g., earnings). Perhaps motivated by the view that, nowadays, the costs of disclosure are small relative to the benefits, recent government policies have increased disclosure requirements, such as Sarbanes-Oxley, Regulation FD, and Dodd-Frank.