Buffet Lunch
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Pat Cox
Former President of the European Parliament
Richard Bruton, T.D.
Minister for Jobs, Enterprise and Innovation
Video Message
Michel Barnier
European Commissioner for Internal Markets & Services
Ugo Bassi
Director for Capital and Companies, DG Internal Market & Services,
European Commission
Panel Discussion
European Commission’s Action Plan on Company Law and Corporate Governance
Pat Cox
Paul Haran
Chair
Chairman, UCD, Michael Smurfit
Graduate School of Business and
Director of Glanbia
Former President of the European
Parliament
Ugo Bassi
Director for Capital and Companies, DG
Internal Market & Services, European
Commission
Chris Hodge
Head of Corporate Governance, UK
Financial Reporting Council
Professor Niamh Brennan
Professor of Management, UCD
Dr. Thomas B. Courtney
Arthur Cox, Dublin
Coffee Break
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Pat Cox
Former President of the European Parliament
ECGI Session
Short-termism, the impact of financial markets and the UK Kay Review
Professor Patrick Bolton
Jörgen Holmquist
Professor of Business, Columbia
Business School
Chair
Chairman of the European Corporate
Governance Institute, former Director
General, DG Internal Market & Services,
European Commission
Professor Alex Edmans
Assistant Professor of Finance, The
Wharton School, University of
Pennsylvania
Short-termist Financial Markets and
Corporate Governance Challenges
Professor Patrick Bolton
Professor of Business, Columbia Business School
Short-termism in one Cartoon
“Yes, the planet got destroyed, But for a beautiful moment in time we created a lot of value for
shareholders.”
Financial Markets are Structurally Short-termist
Why?
• One reason is that Financial Markets are incomplete
• Stock prices reflect present discounted valuations of incomplete cashflow streams
• A key omitted impact on future cash-flows: climate risk
• At some point in the near future the world will have to price
Greenhouse Gas Emissions and the price will be steep
• Where is carbon pricing risk reflected in current cash-flow projections?
The Long-Term Value of ESG Factors
ESG: Environmental, social and corporate governance
• Eccles, Ioannou and Serafeim (2011): Compare a matched sample of
180 companies and find that
• Companies that have adopted ESG policies have higher long-run
stock market and accounting performance.
• Major obstacle in the short run: lack of standardized measures of ESG
(“integrated accounting”)
The Long-Term Value of ESG Factors
The Long-Term Value of ESG Factors
ESG Factors: Google word search trends
Short-termist Financial Markets:
Extrapolation Bias
and
Excess Volatility
Extrapolation Bias and Excess Volatility
Excess Volatility
•
Jeremy Grantham, Co-Founder and Chief Investment Strategist,
Grantham, Mayo, Van Otterloo (GMO):
“we are 19 times more volatile than the clairvoyant series—19 times more volatile
than is justified by the underlying stable data to a long-term holder. This is not
impressive. This is not efficient. I have spent 30 years being extremely irritated
listening to the intellectual torturing of logic to explain that it is in fact a rational
market. ”
Excess Volatility
Kay Report:
We question the exaggerated faith which market
commentators place in the efficient market hypothesis; the
theory represents a poor basis for either regulation or
investment
Excess Volatility
•
How is it possible to be so inefficiently short-termist?
•
Forecasting methods: Fuster, Hebert and Laibson (2011) -> robust short-term
forecasting => too little correction for long-run mean-reversion (too few lags)
•
Extrapolation bias: (Barberis, Shleifer and Vishny 1998, Hirshleifer and Yu,
2012) DSGE models with extrapolative expectations explain better key stylized
facts about asset prices and macroeconomic variables than existing rational
models
Short-termism
•
Limits to Arbitrage: (Dow and Gorton 1995, Shleifer and Vishny 1997, Abreu
and Brunnermeier 2003)
•
Speculation: Differences of opinion + short sales constraints (Scheinkman
and Xiong 2003, Bolton, Scheinkman and Xiong, 2006)
=>
Stock Price = fundamental value +
speculative option value
Shorter holding periods in the US
The average holding period has been decreasing for 45 years:
Years
Average Holding Period for a stock on the NYSE
(in years)
Source: NYSE overview statistics
UK and Europe…
Average Holding Period for a stock on the FTSE
(years)
Average Holding Period in other major stock
exchanges (in years)
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
9
8
7
6
5
4
3
2
1
0
Source: London Stock Exchange
Source: World Federation of Exchanges
Cremers, Pareek, and Sautner (2013)
Cremers, Pareek, and Sautner (2013)
Kay Report:
Public Equity Markets currently encourage exit (the sale of
shares) over voice (the exchange of views with the company)
Short-termism
•
Incentive distortion resulting from short-term performance measurement
(Stein 1988, 1989, Diamond 1991, 1993 and Von Thadden 1995)
•
Short term incentives and benchmarking for asset managers (mutual
funds & pension funds)
(Vayanos and Woolley 2011)
Short-termism: The effects on corporate investment
Graham, Harvey and Rajgopal (2005)
 “More than three-fourths of the surveyed executives would give up economic
value in exchange for smooth earnings […]
 Many executives feel that they are choosing a lesser evil by sacrificing longterm value to avoid short-term turmoil […]
 Many managers would reject a positive NPV project in order to meet the analyst
consensus estimate!”
 Alti and Tetlock (2013) Journal of Finance
What can be done to lessen the Short-termist
pressures of Financial Markets?
Existing Long Term Incentives…
• Reduced capital gains taxes for long term (buy-and-hold) investors
• Longer term executive compensation (longer vesting periods, escrow accounts
& clawback provisions)
• Rewards for long-term shareholders: Extra voting rights, shares (Air Liquide),
dividends (L’Oreal)
• Financial Transaction Tax
• No quartely earnings guidance (Coca-Cola, IBM, Google, etc.)
• … are likely not sufficient to properly align Long-term goals of firms,
managers and shareholders.
Other Solutions?
• Promote integrated financial accounting which measures ESG factors (Eccles
et al. 2011)
• Loyalty Shares (Bolton and Samama, 2012)
L-Shares : The basic idea
All shareholders are
entitled to a Loyalty
Warrant
Loyalty period
(3 years)
Exercise period
(3 years)
The Long-term shareholders having kept their
shares for three years
Warrant = 1
The Short-term shareholders having sold their
shares
Warrant = Ø
Behavior of shareholders determines ownership
(or not) of the warrants
Here Comes the Slow-Stock Movement
(WSJ 22 March 2013)
•
•
•
Henry Jackson Initiative, Towards a More Inclusive Capitalism, May 2012
World Economic Forum, Measurement, Governance and Long-term Investing, March 2012
Institutional Investor, Can Loyalty Shares Programs Help Build Long-term Value for Investors, October 2012
EU Commission Green Paper on Long-Term Financing of
the European Economy, March 2013
‘Ideas have also been advanced to encourage greater long-term shareholder
engagement, which could be subject to further consideration, such as analysing the
possibility of options around granting increased voting rights or dividends to longterm investors.’
Conclusion
• Short-termism of Financial Markets is a major problem
• Solutions are available, but so far little has been done to respond to shorttermist pressures short of delisting
• A major area in need of reform is the governance of asset management firms
and the compensation of asset managers  pension funds who are investing
for the long-term rely too much on short-term performance benchmarks
Kay Report:
This conflict between the imperatives of the business model of
asset managers, and the interests of UK business and those
who invest in it, is at the heart of the problem of short-termism.
Corporate Governance and Short-Termism: Challenges
and Solutions
Professor Alex Edmans
Assistant Professor of Finance, The Wharton School, University of
Pennsylvania
Outline of Talk
• Executive compensation


What’s right, what’s wrong, and what’s fixable
Particular emphasis on short-termism
• Short-termism of shareholders
• Short-termism and disclosure policy
Executive Compensation
• Many high-profile examples of inefficiency (e.g. high pay, golden
parachutes, rewards for failure)
• Policymakers: “first do no harm”
• Role of academic research: are the above inefficiencies limited to a few
high-profile examples, or generally true?
Level of Pay
• #250 CEO in the US earned $9m in 2008: a sixfold increase since 1980

300 times a rank-and-file employee
• But pay has fallen 40% since peak; average worker pay hasn’t fallen so
fast
• Bebchuk and Fried (2004): rent extraction
• Gabaix and Landier (2008): pay is for talent. It’s competitive forces


Similar “superstar” effect to footballers, movie stars
Compare CEO pay not to worker pay, but contribution to firm
Level of Pay
• Certainly, some CEOs are overpaid – but a few bad apples, rather than
a rotten entire cart
• Problems with regulation:


One-size fits all
Can be easily circumvented, e.g. $1m salary cap
• Shareholders / boards have incentives to set the optimal pay scheme.
Regulation can help by


Giving shareholders voice (e.g. say-on-pay legislation)
Mandating disclosure: facilitates both voice and voting with your feet
What Could Be Fixed: Excessive Risk-Taking
• Pure equity compensation induces excessive risk-taking at expense of
bondholders
• Edmans and Liu (2011): optimal compensation involves both debt and
equity

Sundaram and Yermack (2007): defined benefit pensions and deferred
compensation
• Bolton, Mehran, and Shapiro (2011): tie compensation to CDS spread
• AIG changed its compensation to explicitly tie executives to debt
• Liikanen Commission recommended debt-based pay
What Could Be Fixed: Short-Termism
• Incentives often have short vesting periods, allowing CEOs to cash out
early



Countrywide CEO sold $129m of stock in 12m before 8/07
“Before the Bust, These CEOs Took Money Off the Table” (Wall Street Journal,
11/20/08)
Bebchuk, Cohen and Spamann (2010): top management at Bear Stearns and
Lehman earned $1.4bn and $1bn from cash bonuses and equity sales in 2000-8
Effects of Short-Term Horizons
• Encourage bad short-term actions


Johnson, Ryan, and Tian (2009): unrestricted stock linked to corporate fraud
Gopalan, Milbourn, Song, and Thakor (2012): short-duration equity is associated
with earnings management
• Discourage good long-term actions


Edmans, Fang, and Lewellen (2013): imminently-vesting stock and options is
associated with R&D cuts
Edmans (2011): intangible investment takes several years to show up in stock prices
The Dynamic Incentive Account
•
•
Edmans, Gabaix, Sadzik, and Sannikov (2012)
Escrow the CEO’s pay into an account, of which (say) 60% is in stock, the
remainder is in cash

•
“Constant percentage principle” – rebalance the account so that % of stock
remains 60% at all times

•
“Long horizon principle” – account vests gradually, including after retirement
 Superior to clawbacks: prevention, not cure; runs on auto-pilot
Re-incentivizes the CEO after the stock price drops, without rewarding him for failure
Can be implemented with deferred cash and restricted stock, without need to
set up an account
Short-Term Shareholders
•
View that long-term incentives will only be implemented by long-term
shareholders


•
•
Calls for transactions taxes, short-sales restrictions to “lock-in” investors
1980s advocacy of Japanese model
Shareholders who are short-term and uninformed will indeed trade on shortterm earnings (Bushee (1998))
But, informed shareholders with the option to sell in the short-term can exert
governance


Large stakes induce information gathering
Liquidity provide option to sell
Governance Through Exit
•
Traditional view: shareholders govern through voice

•
If a manager is underperforming, or boards are setting inappropriate contracts,
shareholders can “vote with their feet” / follow the “Wall Street Rule”

•
•
•
But, hard to implement in practice
Admati and Pfleiderer (2009), Edmans (2009), Edmans and Manso (2011)
Conditional long-termism > unconditional loyalty
Bharath, Jayaraman and Nagar (2012): liquidity improves firm value, particularly
if blockholders
Edmans, Fang, and Zur (2013): liquidity induces blockholder formation
Disclosure
• Financial crisis has precipitated calls for increased disclosure


Sarbanes-Oxley
Regulation Fair Disclosure
• Increased disclosure of executive compensation is indeed desirable
• But, increased disclosure of earnings can induce short-termism




Kay report
Google, Porsche
Theory: Edmans, Heinle, and Huang (2013)
Evidence: Ernstberger, Link, and Vogler (2011) on EU
Panel Discussion
Reaction to ECGI Session
Professor Colin Mayer
Chair
Peter Moores Professor of Management
Studies, Saïd Business School &
University of Oxford
Chris Hitchen
Chief Executive of the Railways Pension
Trustee Company, Chairman of the
Pensions Quality Mark & Member of the
Advisory Board for the Kay Review
Professor Patrick Bolton
Professor of Business, Columbia
Business School
Myles Lee
Chief Executive, CRH plc
Professor Alex Edmans
Assistant Professor of Finance, The
Wharton School, University of
Pennsylvania
Jörgen Holmquist
Chairman of the European Corporate Governance Institute, former Director
General, DG Internal Market & Services, European Commission
Presentations will be available on
www.corpgov2013.com
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