The Conference Board
Governance Center Blog
By Charles M. Nathan, Senior Advisor, at Finsbury
Conference Board Governance Center has been heavily engaged in the current
discussion in the marketplace on “long-termism versus short-termism,” most
notably with our publication of the report “Is Short-Termism Jeopardizing
the Future Prosperity of Business.” At the Governance Center, we believe
in presenting differing points of view. In the following post, Charles
Nathan presents a contrarian view and challenges some of the conclusions
of our report. We encourage others to engage in the debate and consider
other points of view.
current discussions about the reasons for our weak economic recovery, a
number of propositions have achieved the hallowed status of articles of
faith among public company managements, many notable observers of our
economy[i], the financial press, the political classes and great swathes
of the public. Three of the most cherished are that short-termism is bad,
long-termism is good and activist investors are responsible for much of
the short-termism afflicting corporate America. These alleged truisms are
based on a series of critical fallacies.
Fallacy One: Increasingly rapid portfolio turnover and high frequency
trading contributes to corporate short-termism.
Proponents of this thesis ignore the underlying reality. First, the bulk
of institutional investors—the mutual fund complexes (whether actively
managed or indexed) and managers of public and private pension funds and
foundations–are long-term investors. The rise in average portfolio
turnover statistics on which the fallacy is based is not attributable to
conventional institutional investors, even those with discretion over
their portfolio positions. Rather, it is due to misinterpretation of the
meaning of the statistic. The often cited increase in average portfolio
turnover is not an accurate portrayal of reality because the statistic
gives equal weight to every fund regardless of its size and regardless of
its investment objectives, thereby overemphasizing both smaller funds and
funds with extremely high portfolio turn-over. A more accurate measure of
institutional portfolio turnover is the asset-weighted turnover rate. In
2013 the average asset-weighted turnover rate for the entire mutual fund
industry was 41%, well below the average of the past 34 years and belying
the assertion that investors are more short-term oriented than ever.[ii]
Moreover, portfolio turnover (however measured) does not have an
appreciable effect on company behavior. Rather, companies are influenced
by the balance of supply and demand for their stocks. A public company is
relatively indifferent to the investment strategy of purchasers of its
shares and their targeted or actual holding periods. Rather a company
cares about whether there are more net buyers than net sellers. True, a
company would always prefer that demand for its shares come from long-term
holders, but at the end of the day it is the movement of the price of its
shares that motivates its behavior not the holding period of its
Fallacy Two: Activist Investors are Short-Term Investors.
Activists, like all qualitative investors, want to make a profit on their
position, and they are willing to hold a position for years if they
believe it will result in gains. Indeed, a number of studies have
demonstrated that, on average, activist investors maintain their position
for a matter of years, not months.[iii] Moreover, there is no rational
reason to think that long-term shareholders (whatever that term means)
have greater insights into or understanding of corporate decisions and
strategy than short-term investors. For example, if the long-term holder
is, as increasingly is the case, an index fund, by hypothesis its
investment has nothing to do with a company’s strategy or business
decisions, and the investment manager has no basis to claim any special
knowledge or insights into the reasons for the company’s performance.
Fallacy Three: Long-term is good and short-term is bad.
Castigating a corporate strategy as short-term, rather than long-term,
simply misses the point. The issue is not the duration of time required
for implementation, but rather the value creation potential of the
program. No rational investor, or company manager, would (one would hope)
advocate adoption of a longer-term strategy over a shorter one, if the
shorter one had a higher value creation opportunity.
fundamentally, there is nothing innately virtuous about the long-term,
whether it be the duration of a portfolio position or a company strategy,
nor is there anything innately evil about a short-term holding period or
implementation period for an alternative company strategy. Notwithstanding
this obvious truism, critics of activist shareholders consistently assume
short-term is bad and long-term is good. Repetition of these baseless
assertions may have its purposes, but describing reality is not one of
them. The reality, of course, is that there are both good and bad
short-term strategies, just as there are good and bad long-term ones. The
only relevant issue is determining which strategy will create more net
present value for the company and its constituencies, not which one will
take longer or shorter to implement.
Fallacy Four: Activists stampede boards into adopting the activist’s
Activists are not alchemists who nefariously transmute relatively small
share ownership positions into the power to compel companies to adopt
wrong-headed policies which are rightly opposed by their boards and
managers. Rather, activists are wholly dependent on the support of at
least a majority of a company’s other shareholders to achieve their goal
of changing some aspect of a company’s business or strategy. The activist
investor’s typical game plan is simple and consistent.
identify a company that is undervalued in the market because it is not
fully realizing its potential.[iv]
Second, propose a solution to management that the activist believes will
unlock the full value of the company.
if management is unwilling to work with the activist to improve the
company’s operations or strategy, bring the activist’s proposed plan to
the company’s shareholders who have the final say on company policy
though their ability to vote at shareholder meetings.
nothing nefarious about giving the owners of a company a choice between
competing strategies or alternative business plans. Nor is there anything
wrong if a majority of shareholders agree with the activist, rather than
management. To suggest the contrary is to advocate a corporate system in
which management has the final say on all matters, and shareholders have
no power to vote managers out of office—a model that might be conventional
in Russia but is antithetical to the very premises of our corporate
simply, the argument against activist investing boils down to a classic
case of blaming the messenger. Activists don’t possess some magical power
which allows them to bewitch shareholders. Rather, they present a case for
their proposed solution to what they perceive as a company’s shortcoming,
and management presents its case. Whether management’s case is in defense
of a long-held strategy adopted in good faith by the board, or a recently
created attempt to “be your own activist”, the bottom line is that
shareholders are the ones who get to decide. If they decide against
management, it is hardly the fault of the activist. Viewed rationally, it
is the fault of management, either because their program is not as
persuasive or because they fail to articulate it successfully.
same vein, if shareholders opt for a shorter-term program and reject
management’s longer term proposal, the outcome is not wrong because
management disagrees. Even if shareholders are pre-disposed to favor
shorter-term programs for extraneous reasons (such as concern for
quarterly and annual performance rankings on the part of active money
managers), it is not because of something inherently bad about activists.
Nor is the solution to penalize activists for their success in harnessing
Fallacy Five: Activists prevent company management and boards from
implementing wise, long-term programs.
ultimate fallacy of the anti-activist mantra is that somehow, for some
reason, it shouldn’t matter that a majority of shareholders often embrace
activist campaigns. There is no principled reason to believe that boards,
management and their advisers know better and should be freed from the
distraction, stress and risks of a debate over their corporate
stewardship. The paternalistic and patronizing view that management always
knows best is simply an inversion of the reality of shareholders’
ownership and rights under our corporate governance system. Defenders of
management against activist investing all too often dismiss the reality
that boards and management are accountable to shareholders on at least an
annual basis and that our corporate governance model is based on the
fundamental principle that shareholders are the owners of the company with
the ultimate right to decide their company’s future.
Conclusion: Critics of short-termism need to understand and effectively
address the market’s bias for shorter-term solutions.
sure, critics of short-termism do not always blame the phenomenon entirely
on activist investors. They also frequently indict so-called “quarterly
capitalism”, as manifested in the stock market’s decades-long focus on
quarterly earnings announcements, earnings management, quarterly
“guidance” and all the other accoutrements of quarterly financial
reporting. They also blame investors for “overly” discounting the risks of
long-term corporate strategies and thereby not giving management’s value
creation predictions sufficient credence.
undoubtedly some truth in these criticisms, but what is the remedy? It
surely is not to berate activist investors who at best prescribe desirable
changes in a company’s strategy and at worst favor financial restructuring
over investment in long-term but uncertain business plans. Nor is it to
demand that the market somehow just abandon its sometimes preference for
shorter-term programs over management’s longer-term preferences.
simple, unalterable bottom line is that the institutional investment
managers who manage the overwhelming majority of funds invested in the
stock market, are motivated by a single over-riding imperative—gathering
funds to manage and retaining those funds. The source of these funds
ultimately is the American public, whether through personally managed
accounts or, far more commonly, through mutual funds and public and
private pension plans. People who save money, through whatever mechanism
and whether directly or indirectly, all share the same very obvious
goal—to increase the amount of money held for their account.
blunt, the custodians of the vast bulk of the American public’s savings,
the institutional Investment managers, dance the tune that the American
public plays. In the immortal words of Walt Kelly’s Pogo: “we have met the
enemy and they is us”. If an investment manager out-performs her
benchmarks, she will be rewarded by being given more funds to invest. If
she underperforms, no matter how loudly she protests that given time she
will do better, far better, than her benchmarks, she almost certainly will
lose funds under management. Inveighing against quarterly capitalism and
its hand maidens, no matter how impassioned, is just not going to change
the stock market’s behavior.
is the answer to whatever short-term bias affects the stock markets? The
only rational one is that managements and boards have to do a far better
job of convincing their investors that their long-term programs will, in
fact, create greater net present value than the shorter-term alternatives.
If companies can do this, their investors will not reduce their ownership
of the companies’ stock during periods of relatively lower earnings (or
even losses) because investors will have confidence that in the longer-run
management will turn out to be right. A notable number of our most
successful and admired companies have been able to do just this—think
Amazon, Tesla, Facebook, and Google. Quite simply, this is the only real
antidote to investors’ bias towards shorter-term alternatives.
views presented on the Governance Center Blog are not the official views
of The Conference Board or the Governance Center and are not necessarily
endorsed by all members, sponsors, advisors, contributors, staff members,
or others associated with The Conference Board or the Governance Center.
including The Conference Board. See “Is
Short-Term Behavior Jeopardizing the Future Prosperity of Business?”
Investment Company Institute Research Commentary “Mutual Funds and
Portfolio Turnover”, Nov. 17, 2004; Investment Company Institute 2014
Investment Company Fact Book at pp. 36-37 (54th
FTI Consulting, “The Shareholder Activists’ View/2015 Second Annual
(Part II of II); Prequin Special Report, Activist Hedge Funds
Conference Board recently published a paper, “How
Activist Investors Identify Their Targets” (2016).
Nathan Senior Advisor Finsbury
Charles Nathan is a senior advisor at Finsbury, a global strategic
communications firm. He also is an adjunct professor at both Yale Law
School and Columbia Law School where he teaches an advanced M&A seminar.
Mr. Nathan was formerly a partner at Latham & Watkins where he co-chaired
the firm’s global M&A Group and Corporate Governance Task Force. Finsbury
is a member of The Conference Board Governance Center.
2015 The Conference Board Inc.