Crime Prevention-Corp Gover (Final)

8/3/2019 Crime Prevention-Corp Gover (Final)

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SHORT-TERMISM:Effect on the UK Stock Marketand its Implications for UK

investorsBy:

Aaron JohnSteve Caku

Tang Hao-YangCarl OSullivan

Zamil ImamVinay Kalsi


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SHORT-TERMISM

the tendency to focus attention on short-term gains, oftenat the expense of long-term success or stability. CollinsEnglish Dictionary

It is argued to be associated with restricted investment intangible and intangible assets; this follows the argumentthat a preference for short-term performance leads to

unintended consequences for long-term value addingcapability of the firm (Porter, 1992)

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League Table- Marsh (1990)

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The Popular Verdict

A Study by Marsh in1990 indicates that theUK had the lowest GDP amongst Germany,

Japan and USA

Why?

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The Popular Verdict

Two Reason...

People have Invested too little in their nationalwealth

Differences in the financial systems

Germany and Japan are bank based

UK and USA are market based

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The Popular Verdict

Financial markets, fund managers andanalysts are short-term oriented

Thus, the stock market places too muchemphasis on short term results and too little

on longer term

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Rough Justice

Although there is not much evidence to support theexistence of short-termism

There is a heavy emphasis that analyst andmanagers place importance on short term results(Marsh, 1990)

Forced to focus on short term goals rather than onlong term goals

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How Do Share Prices Behave?

Do they fairly reflect both short and long termprospects?

Does short-termism exist in share prices?

Research suggests that there is not muchevidence to prove the existence of short-termism in share prices

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Short-Termism is possible when...

Too much emphasis is placed on current PE ratio(Price-to-Earning)

P/E Ratio: Price per Share divided byAnnual Earningsper Share

If companies are valued by multiplying current earnings

by the P/E Ratio, then, stock market valuations would bedriven by current earnings rather than future prospects

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Does Short-Termism exist in theUK Stock Market?

No hard evidence to suggest so

The market is not myopic (short-sighted)

Literature suggests that the market has had

a preference for capital gains rather thandividends

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Does Short-Termism exist in theUK Stock Market?

Studies indicate that share prices react to capitalexpenditure, R&D, investment in new products which arelong term prospects

These are regarded as good news and thus share pricesincrease placing an emphasis on the overall strategy (longterm)

Studies of Strategic long investment finds no evidence ofshort-termism (Marsh, 1995; Bushee, 1998)

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Analysis of the UK Stock Market:Duress as an Extenuating Factor of

Short-Termism

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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism

1. Pressures from the Share Price and Dividends

No evidence of any short-term trend in share prices

Market does not penalizes companies which make long-term investments bylowering their share price

Companies discouraged from LT investment by weakness in share price orpressures to maintain dividends

Concern about Dividends

Dividend payouts - which are higher in UK / USA - reason why UK/ US companieshave invested less than German / Japanese companies

UK payout ratios seen as a cause and as an attempt by companies to keep theirshare prices high to ward off predators (argument based on false premise)

Well-managed firms start from the premise that they should invest in all worthwhileprojects

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Disagreements about the Share Price

Corporate management may disagree with the markets rating of their shares.

(asymmetry of information between management and shareholders). If gap betweenmanagements and the markets rating of the shares grows too wide, management

has to communicate this to the market

Companies disclose too little of their long-term plans and developments to themarket

2. The Behaviour of Analysts

Main criticism : they appear to be obsessed with short-term earnings and dividends

Part of the problem : quality of analysts and in the nature of the dialogue they havewith companies

Many of bad analysts do not really understand the companys businesses, markets

or technologies, worse some of them believe that the stock market actually valuesshares on a purely short-term basis

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Corporate managers cannot be blamed to have the impression:analysts do not understand them and are short-termist. BUT manycan choose to discuss or disclose information relating to their long-term plans and developments with analysts

3. Fund Managers and Quarterly Performance Measurement

Fund managers seen as been put under short-term pressures bythe fact that their portfolio performance is measured on a short-term, quarterly basis

Corporate management, if faced with the requirement to max profitseach quarter, might be tempted to increase short-term profits byneglecting the firms long-term future

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The fund managers help to keep the market efficient

To the fund manager, maximizing short-term performance is equivalent tomaximizing long-term performance.

Quarterly Performance Measurement Nothing wrong with quarterly performance measurement, actors have to understand

how this measurement should be interpreted

The main danger : lies in the misunderstandings which surround the activities of thefund managers and the performance measures. These seem to create a generalshort-termist impression in the eyes of corporate managers

4. Speculators or Owners?

The institutions (which hold over 70% of UK shares) it is argued they have becomemore like speculators than owners with high levels of turnover being a key indicatorof this

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There are 4 strands to the concerns about speculative activity:

1) Is Turnover Bad?

strong suggestion that turnover is bad. The belief seems to be that high turnover implies shorter investmenthorizons and therefore more interest in short-term values

-BUT suggestions that turnover is bad are misguided. It may be helpful to categorize stock-

market turnover into 2 broad categories: liquidity-motivated and information-motivated

2) Turnover and Volatility

belief that institutional turnover leads to excessive stock market volatility.

Brealey, et. Al (1978) found no evidence but they found that markets were (and

always had been) subject to periodic shocks

3) Investors Time Horizons

There is a worry that turnover can lead to investors having different time horizons than the companies in which they invest

4) Turnover and Relationships

The shorter the institutions shareholding horizons, the more difficult becomes for companies

to establish meaningful relationships

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The Evidence on Turnover Levels

Institutional investors (perceived) behavior in the areas of shareholder responsibilities,

shareholders role in the affairs of companies, and their loyalty in the face of an unwelcome bid

influence managerial behavior and could place managers under duress, causing them to

behave in a short-termism manner

5 Takeover Activity: Direct Duress

One source of direct duress which is brought to bear on companies is the threat of an

unwanted takeover bid

Management worries excessively about short-term profit and

dividend performance to keep the share price high, and this causes them to cut back on long- term investments and focus instead on maximizing short-term profits. They are thus distracted

from the longer term, and coerced into short-termism

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TAKEOVER ACTIVITY

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Takeover Activity: Direct Duress

One source of direct duress which is brought to bear oncompanies is the threat of an unwanted takeover bid

Management energies are diverted into excessively

worrying about short-term profit and dividendperformance to keep the share price high. This causesthem to cut back on long-term investments and focusinstead on maximising short-term profits

They are thus distracted from the longer term, andcoerced into short-termism

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Let the punishment fit the crime?

By the time it becomes evident that our totally free

market in corporate control is seriously damaging to

the nation, it will be too late.

Marsh(1994)

The financial impact of takeovers

The fundamental flaw

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The Financial Impact of Takeovers

After at least 50 studies on takeovers activity. Marshfinds that the acquirees shareholders gain frommergers and if acquirers shareholders do not lose,

there must be net gains to shareholders fromacquisitions. These have been reflected in a highermarket capitalization for the combined entity than for thetwo original firms run separately

The punishment (takeover) fits the crime (poorperformance, coupled with too little investment for thelonger term)

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The Fundamental Flaw

It assumes that companies can increase their shareprice by cutting longer-term investments in order tomaximize current earnings

All findings

-They all relate to average behavior. When we look atthe small average gain to acquirers shareholders, we

can interpret this as saying that only just over half theacquisitions were successful from the acquirers

viewpoint

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The Fundamental Flaw

-The available evidence relates almost exclusively toshareholders interests. There are many other interestedparties in a merger, such as managers, employers,

customers, suppliers and the tax authorities

-The figures do not take into account all the hiddencosts and benefits of takeover activity. For example,

they ignore the substantial costs in terms of fees,management time and employee motivation associated with failed bids

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Our Competitors

The caveat of all, in this context is the fact thatsome of our (the UKs) most successful

competitors internationally are, Japan and

Germany

There are many other possible explanations forthe relative success of Germany, and more

especially Japan. Their respective financialsystems contain a number of alternativemechanisms to the discipline of takeovers

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If the financial markets are notto blame for a lack of longterm investment then who is?

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Three main sections

The popular myth of financial marketsbeing short term has influenced corporate

managers Managerial short-termism behaviour aside

from financial markets

A lack of profitable investmentopportunities

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Section 1: The Influence of Popular Short-Termism Perceptions on Managers Decisions

If corporate managers believe there is a short-termismproblem associated with capital markets this could negatively

influence their decisions. Study indicates this may betrue(Grinyer; Russel and; Collison,98)

Especially if financial institutions behave in a way describedas conduct likely to mislead by not disclosing enough

information about their long term prospects

If managers believe high short term profits preventstakeovers this may be influential in their decision makingprocess

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Section 2: Managerial Short-TermismIndependent from Financial Markets

Managerial remuneration and rewardssystems

Time horizons spent with a firm Capital budgeting and project appraisal

systems

Relationship between head offices anddivisions

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Managerial Remuneration

The problem is that due to a separation of ownership and controlthe owners need to decide on a compensation package thatrealigns manager and shareholders interests

There are three options for this compensation: fixedcompensation; market based performance measures and; stockoptions

It is argued that market based compensation focuses managersattention too much on short term profits as it is linked to

accounting measurements. A study by Quinn () showed that80% of managerial pay was linked to short term agendas

Study by Healy () shows that long run remuneration systems canwork. Japan

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Time Horizons

Executive mobility is high and increasing

rule of thumb executive managers typically

spend 3 years on the job and 5 years with a firmin the U.K Andthe U.S

Thus this may be problematic in gettingmanagers to adopt a long term outlook

The Japanese exercise lifetime employmentincluding job rotation and various othermeasures

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Relationship between Head Offices andDivisions and Capital Budgeting

Head offices influence on their divisions are very influential for

three reasons: capital budgeting; decision on which projects topursue and; setting the right climate

Head offices often using the wrong method (payback method) may

forgo positive NPV projects

Furthermore there are information asymmetries between the headoffices and their divisions. Therefore the head offices may not be inthe best position to judge just which project is the best to undertake

Study Barton (1989) found that employees from these divisions felt

that the greater degree of control the larger number of opportunitiesmissed with 25% believing that ideas were lost in the decisionmaking process

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Section 3: Lack of Profitable InvestmentOpportunities in the UK

Cost of Capital i.e. Easier and cheaper in somecountries to raise finance than in the U.K. Also investorswill require a higher rate of return

Historical Influences

Macroeconomic Factors

Supply Side Factors

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Cost of Capital

Cost of capital is derived from two sources the cost ofequity and the cost of debt

Cost of Equity i.e. Real interest rates and comparative

risk premium Marsh finds that there is no large difference between:

the U.K.; U.S.; Japan and; Germany in both theseaspects

Cost of Debt i.e. Capital Structure Marsh finds that there may be a small advantage for

Japanese and German firms due to their higher gearing

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Macroeconomic factors

Inflation and exchange rate volatility. Highinflation particularly in the 70s may have

negatively impacted on long term investment

Historical influences

Britains historical significance as the former

world leader is negatively impacting on longterm investment. For example high defenceexpenditure

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Supply Side Factors

Argument that the labour productivity wasinadequate due to poor training and poor

capital per worker in the U.K. Giving othercountries a productivity advantage

Marsh discusses the Union movementpossibly overmanning plants as a way ofjob protection

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Crime Prevention

How can you prevent short-termism?


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Prevention

Analysis of previous sections

If the remedies do not tackle the problem itmay harm corporate sectors

With these dangers in mind, we put forwardtwo measure that combat the problem ofshort-termism


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Radical but Inappropriate measures

Several of these measures are eitherunrealistic or inappropriate (or both)

The German and Japanese financialmodels are more successful

The UK changing its financial system to theGerman and Japanese models isinappropriate! Why?


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Radical but Inappropriate measures

German and Japanese bank-basedfinancial systems

There are advantages

This has suggested that the UK shouldadopt a bank-based rather than a marketbased system


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Strengths & Weaknesses

Each system has its own strengths andweaknesses

Some systems are good for an economy ata certain stage of development

Securitization of debts in Japan


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British & American Market-BasedSystems

Advantages of such a financial system

Why is access to such markets important?

Transplant of markets is extremely difficult

Countries respond to its specific needs

Difficult to replicate


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Fiscal Sticks & Carrots

Sticks try to cure short-termism in shareprices

But, does such a problem exist?


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Measures to improve relationship andcorporate control

Have some merits but.

Involves greater monitoring which can becostly

Commonality of interest between managersand institutional shareholders


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Measures to improve relationship

Firms should be run in the interest of theshareholders

Owner-Agent problem (DifferentObjectives)

Example: Solomon Brothers(Hagstrom, 1994)


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Shareholders role, responsibilities andloyalties

Can combat short-termism

Take greater interest in the investing business

Be prepared to intervene if necessary

Show greater responsibility and loyalty tocompanies (Marsh, 1990; Grinyer et al. 1998)


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Shareholders role, responsibilities andloyalties

The notion/belief is that it leads to long term

value

This would result in better monitoring and

control of the management (Kostant, 1999)


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Hurdles

Barriers and constraints to gains. Lack ofinformation to intervene

UK corporations finding it difficult tocooperate and act collectively

Free Rider problem (Black & Fraser, 2000)


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CORPORATE GOVERNANCE

The main emphasis of corporate governance inshort-termism is

to ensure that companies are run properly

This is achieved through a well constituted board

Why is a well constituted board necessary?


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Crime Prevention & Conclusion


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Shareholder Loyalty

How should institutions react to a contestedtakeover bid?

One approach is to side with the incumbent

management because: If the bid fails their share price is unlikely to drop

Bradley (1983)

If institutions continuously side with the acquirer'sthey may gain a reputation of disloyalty causingmanagers to take a short-term defensive outlook


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However siding with the incumbent may beunrealistic because:

The institution may well have investment inthe acquirors equity also.

Current management may not be good enough.

There may be commercial logic to a sale

Thus the best approach for institutionalshareholders is for better communication


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Communication

Marsh advocates better communicationbetween firms, their shareholders and potentialshareholders

However it may be difficult for management todo so as it may leads to disclosure of important

information to competitors in market


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Conclusion

Often investing institutions and industryrelationships give impression of short-termismAccording to Crafts (1998) many analysts have notaddressed side-supply problems ( related to labour

force, productivity and to the quality ofmanagement) completely Government involvement plays an important role. Challenges at international marketplace should be

tackle from within the organisation More emphasis on education, training and

development at all level of organisation


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CITATION

Black, A.J., & Fraser, P. (2000), International comparisons onstock market short-termism: How different is the UKexperience?, The Manchester School Supplement, 1463, pp.38-50

Brealey, R.A., Byrne, J. and Dimson, E. (1978), Thevariability of market returns , TheInvestment Analyst, 52,pp.1923

Bushee, B.J. (1998), The influence of institutional investors inmyopic R&D investment behaviour, The Accounting Review,73(3), pp. 305-334


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CITATION...

Dimson, E., & Marsh, P. (1995), Capital requirement forsecurities firms, Journal of Finance, 50(3), pp. 820-851

Grinyer, J., Russel, A., & Collison, D. (1998), Evidenceof Managerial Short-termism in the UK, British Journal ofManagement, 9, pp. 13-28

Hagstrom, R.G. (1994), The Warren Buffet Way:

Investment Strategies of the World's Greatest Investor,London


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CITATION...

Kostant, P.C. (1999), Exit, voice and loyalty in thecourse of corporate governance and counsels changing

role, Journal of Socio-Economics, 28, pp. 203-246

Marsh, P. (1990). Short-termism on Trial. InstitutionalFund Managers Association, London

Marsh, P. (1994), Capital Markets and CorporateGovernance. Oxford University Press: Oxford


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CITATION...

Porter, M. (1992), Capital choices: Changing the wayAmerica invests in industry, Journal of AppliedCorporate Finance, 5(2), pp. 4-16

Documents

Crime Prevention-Corp Gover (Final)