Don’t Let the Short-Termism Bogeyman Scare You
HBR, Jan 2021
It’s already a cliché that the focus on short-term is detrimental to long-term results. It doesn’t require an IQ above 70 to criticize greedy managers only focused on their bonuses at the expense of poor shareholders.
Lots of tools exist to protect the corporate managers [MK: I’m allergic to the word “leader(s)”] from the cleansing almost guaranteed by the buyer / majority or loud shareholder thinking they can turn the company around and unlock shareholder benefits: staggered boards, takeover defences like poison pills, dual-class share structures and dual-class recapitalization.
The assumption that investors undervalue long-term company prospects and thus share prices don’t include them to the full extent is arguably not based on any convincing evidence. [MK: the currently present huge P/E’s in the stock market prove otherwise, actually. Yes, it’s speculation first and foremost, but still.]
HBR agrees with me saying that growth companies would’ve been discounted (vs pumped up) had the investors been looking only at the short-term results. [MK: and the presence of the eternally money-losing firms (Uber, Airbnb, etc.) would be unthinkable.] And yet growth stocks are trading at higher prices now and lower discount rates than a prudent growth investor would predict.
The article makes an obvious argument of Amazon and Netflix – the two amazing companies artificially lowering their profitability at the expense of self-funded growth. [MK: suffice to say that there’s a world of a difference between companies that have a clear path to the desired profitability and those which don’t.]
But it is true and helpful for all corporate managers to understand that if the stock market doesn’t reward the firm with the increasing share price – there’s something wrong with the firm’s long-term prospects, its management or the business (or all three), not that the investors are collectively ignorant.
The mainstream thinking about activist investors is that they prioritize short-term results vs long-term, and that after the company’s governance becomes more shareholder-friendly (AKA delivering higher payouts via stock price appreciation or a dividend stream), its long-term prospects (reflected in the share price) become dim, but the raiders are happy. The article makes a point that while this is a compelling argument everyone would agree with, there’s no evidence to back it (i.e. there’s no significant impact on the share price 5 years after the intervention).
Another questionable (in the view of HBR) point is that under a takeover threat firms boost their short-term results supposedly at the expense of the long-term results in order to make the acquisition more expensive; the market participants are ignorant enough not to recognize the long-term damage.
Yet another claim the article makes is that a prospect of hedge fund activism makes corporate managers move faster and do more things as they get under the spotlight – thus enhancing shareholder value. This is most definitely true in the short term; not sure what long-term effect on the morale this creates.
The common view is that long-term investors are good and short-term investors are bad (no loyalty, focus on the short-term results, flip and run, etc.). The article makes a claim that even the long-term investors (e.g. index funds) should routinely review the performance of assets under their management and suggest governance changes if need be.
Activist investors need long-term investors’ support to bring about the needed changes, and they need to provide a compelling argument why an intervention is needed. Long-term investors can benefit from such interventions if this means better governance (which is long-term) and corporate managers’ performance.
Corporate managers supposedly pay too much attention to quarterly results (and the resulting stock price movement) because their compensation (cash and stock) depends on them. In 2021 it looks like a straw man argument, as a lot of modern compensation plans are leaning towards the long-term incentives, thus making short-term cash gains less attractive.