Who Are the Short‐Termists?

In this edited version of her keynote address at the Financial Management Association's Annual Conference last October, the author begins by noting that shareholder turnover in U.S. public companies has increased sharply during the past four decades, rising from a low in the mid‐1970s of around 10%—which implies an average holding period of 10 years—to its current level of over 350%, or a holding period of some three or four months. But this increase in average share turnover in recent decades has also been accompanied by a remarkable growth of long‐term investors. In a recent study, the author and two colleagues used quarterly holdings information from Form 13F to identify short‐term investors—which they defined as having annualized turnover rates over 100%, implying a holding period of less than a year—and long‐term investors—those with a turnover rate below 33%, with holding periods longer than three years. Defined in this way, the presence of long‐term institutional investors in the average public company's shareholder base has more than doubled since the early 2000s. What's more, in an attempt to determine whether the market encourages corporate short‐termism by putting too high a discount rate on—and so under‐valuing—earnings or cash flows that are expected to appear in the distant future, the author points to the findings of two studies by others. In the first of the two, an examination of the pricing of a relatively new derivative known as “dividend strips” shows that the implied discount rate for such “incremental” dividends has actually been higher than the rate applied to the long‐term residual value, suggesting that the market undervalues near‐term cash flows relative to more distant ones. The second of the two cited studies reports that companies with high levels of R&D spending—in other words investments with distant payoffs—are fairly priced in the sense that their future stock returns are comparable to those earned by other companies in the same risk class. In response to the claim that shareholder activists force companies to pursue near‐term profits at the expense of the corporate future, the author cites her own study (with two colleagues) that examines the stock returns of targeted companies from three years before the announcement of an activist's taking a position in the stock to three years after. What they find is that the targets significantly underperformed the market and their competitors in the period leading up to the activists' involvement—and that, after a 5% jump in share prices in response to the announcement, the average performance of the targets was roughly equivalent to their competitors' during the next three years. And, as if reflecting this 5% net gain, the operating performance of these companies, as measured by ROA, improved significantly during this three‐year period. To be sure, there is some evidence that activists discourage corporate R&D. But, as the author (and her three co‐authors) shows in a study published this past year in the Journal of Financial Economics, although corporate spending on R&D does fall (by an average of $15 million per company) in the year following the appearance of activists, R&D as a percentage of total assets remains unchanged, reflecting the tendency of companies to sell assets; and the smaller R&D function becomes more productive, accounting for 15% increases in both new patents and citations during the next three years.