The missing role of controlling shareholders in the short-termism debate

Short-termist behavior by corporations is often seen as a large societal problem. For example, Joe Biden wrote in a 2016 op-ed for the Wall Street Journal: ‘Short-termism . . . is one of the greatest threats to America’s enduring prosperity’.

However, the debate on short-termism has so far largely focused on the US and the UK, while short-termism in other jurisdictions has received much less attention. This can explain why the extensive literature on short-termism has often ignored the role of controlling shareholders. This oversight is important, as controlling shareholders are very common around the world, particularly in continental Europe.

In a recent working paper, I argue that the presence of a controlling shareholder has an important impact on corporate short-termism, regardless of the sources of this short-termism.

Some people believe that short-termism arises from short-termist institutional investors and asset managers, who pressure managers to act in a short-termist manner. For example, short-termist institutional investors and asset managers could vote in support of short-term based executive compensation or the campaigns of short-termist shareholder activists. I call this ‘investor short-termism’.

Whether such investor short-termism exists is heavily disputed. However, it is clearly unlikely to arise in the presence of a controlling shareholder, who can block the transmission of short-termism to managers through their control over the corporation.

Second, short-termism could also be caused by inherent short-term preferences of managers. For example, managers may want to demonstrate good results during their tenure at the corporation, to have a higher chance of obtaining a better-paid job at another corporation. Such ‘managerial short-termism’ can only persist if the long-term shareholders do not have the ability or incentives to monitor the short-termist managers and directors. This type of short-termism is therefore just an example of the classic managerial agency problem, which arises due to a lack of accountability of the managers towards shareholders.

Again, controlling shareholders can solve this type of short-termism: their large ownership stake gives them the incentives and ability to monitor management. For example, controlling shareholders can use their voting rights to nominate directors who will stay with the corporation for the long term, and approve executive compensation that is long-term oriented.

This analysis illustrates that controlling shareholders can solve the investor short-termism and managerial short-termism – provided they are not short-termist themselves. Whether controlling shareholders are more long-term oriented will likely depend on the circumstances, and particularly on the type of controlling shareholders. On the one hand, controlling shareholders have stronger incentives to think in the long term than other shareholders, due to the size and illiquidity of their participation, which exposes them to a larger extent to the long-term cash flows of the corporation. In addition, controlling shareholders typically enjoy idiosyncratic private benefits of control, which cannot be transferred easily. For example, a family shareholder may enjoy private benefits from keeping control over the corporation within the family. This locks in controlling shareholders and forces them to think of the long-term cash flows of the corporation. However, on the other hand, private benefits of control may also incentivize controlling shareholders to act in a short-termist manner. For example, a controlling shareholder may prioritize its own short-term liquidity needs over the long-term investments needed by the corporation.

What can we conclude from this analysis of the role of controlling shareholders with regards to short-termism in corporate governance?

First, some of the solutions commonly offered for investor short-termism or managerial short-termism will likely be ineffective in corporations with a controlling shareholder. For example, discouraging short-termist activists or encouraging long-term shareholder stewardship is unlikely to make a difference, as controlling shareholders dominate the general meeting anyway.

Second, if controlling shareholders are generally more long-term oriented (which is debatable), one can facilitate the creation of control by allowing the separation of cash flow rights from control, for example through loyalty voting rights or dual class share structures. This allows controlling shareholder to diversify, even when they have limited liquidity.

The disadvantage of this last solution is that reducing a controlling shareholder’s exposure to the cash flows of the corporation, also reduces their incentives to care for the long term. In addition, the wedge between cash flow rights and control also increases the risk of the extraction of private benefits—precisely the source of potential short-termism. Therefore, initiatives to facilitate controlling shareholders through multiple voting rights must be accompanied by mechanisms that protect minority shareholders, such as approval of the introduction of multiple voting rights by a majority of the minority shareholders. Only in this way can we arrive at a corporate governance system that truly facilitates long-term value creation.

Tom Vos is a full-time visiting professor and researcher at the Jean-Pierre Blumberg Chair at the University of Antwerp, a voluntary scientific collaborator at the Jan Ronse Institute for Company and Financial Law of the KU Leuven, and a part-time attorney at Linklaters LLP.