Last Monday, at Vanderbilt Law School, I attended a presentation by Jesse Fried (Harvard Law) on his new article, The Uneasy Case for Favoring Long-Term Shareholders (Yale Law Journal, forthcoming). 

The paper’s abstract describes the thought-provoking thesis:

This paper challenges a persistent and pervasive view in corporate law and corporate governance: that a firm’s managers should favor long-term shareholders over short-term shareholders, and maximize long-term shareholders’ returns rather than the short-term stock price. Underlying this view is a strongly-held intuition that taking steps to increase long-term shareholder returns will generate a larger economic pie over time. But this intuition, I show, is flawed. Long-term shareholders, like short-term shareholders, can benefit from managers destroying value — even when the firm’s only residual claimants are its shareholders. Indeed, managers serving long-term shareholders may well destroy more value than managers serving short-term shareholders. Favoring the interests of long-term shareholders could thus reduce, rather than increase, the value generated by a firm over time.

I provide more information about the paper and offer a few thoughts after the break.

For a firm that does not transact in its own shares, Fried claims that the conventional wisdom that favoring long-shareholders is desirable does hold and the interests are aligned for economic value to be maximized (pgs. 26-33). Most public firms in the U.S., however, do transact in their own shares, to the tune of approximately $1 trillion a year market-wide (pg. 6).

Fried shows, in admittedly simplified models, that for transacting firms, favoring long-term shareholders can actually lead to the destruction of economic value (pgs. 33-77).

For a firm that engages in share repurchases (often through OMRs, open market repurchases), Fried shows that favoring long-term shareholders can lead to destruction of economic value. In this case, managers favoring the long-term shareholders (by spending less per share on share repurchases), harm the selling short-term shareholder (by paying them less per share in the repurchase), and may be tempted to destroy economic value by engaging in costly contraction (giving up “economically valuable projects to fund the [stock] repurchase”) or engaging in costly price-depressing manipulation (pgs. 44-51). 

Likewise, for a firm that engages in share issuances, such as acquisition-related issuances or seasoned equity offerings, Fried shows that favoring long-term shareholders can lead to destruction of economic value. In this case, managers favoring the long-term shareholders (by reaping a higher price per share for issued shares), harm the future shareholders that buy those shares at the higher per-share price, and may be tempted to destroy economic value by engaging in inflated-price issuances (pgs. 51-61).

I appreciated that Fried doesn't stop at criticism and that he provides some policy recommendations in his paper, including not empowering long-term shareholders without more consideration (perhaps through empirical research) of the possible economic value destroying decisions that may result. He also mentions that “sharply limiting, if not eliminating, public firms’ ability to repurchase their own shares" (pg. 75). He admits that equity issuances are “indispensable” to public firms, but mentioned during his talk that he would eliminate at-the-money issuances (“ATMs”) where firms sell into the market quietly (pg. 76).

Though I wish Fried would have dug a bit deeper into the policy recommendations and thought the paper repeated itself in a number of places, the paper is definitely worth reading and caused me to think about managerial decision-making more deeply. Professor Fried admitted that his models in the paper were extremely simple, but I think the models make his point, even if the reality of most firms is a good bit more complex.  

(Somewhat) Related Closing Thought on Word Counts. The version of Jesse Fried’s article that we reviewed was 85-journal pages, which makes me think that the Yale Law Journal may not be that serious about their 25,000 of fewer (50-journal pages) word suggestion, at least not for influential authors such as Jesse Fried. [Update: I am told that the article is 28,000 words, which is not substantially over Yale's suggestion, but also means that Yale may be off on their 50-journal page estimate for 25,000 words. Fried's article appeared to be in journal format already, but the spacing might have been a bit different.] See also: Are Word Limits for Suckers? As the linked post on PrawfsBlawg notes, about four years ago the Yale Law Journal was “strongly encouraging” articles under 30,000 words (60-journal pages) and was “strongly discouraging” articles over 35,000 words (70-journal pages), but still publishing articles well over 100-pages long. This word limit issue is probably worth a separate post, perhaps authored by one of my co-bloggers. I know when I was clerking and in practice, the incredibly long length of many law review articles discouraged us from reading very many of them. I do realize, however, that the bench and the bar are not the only, or even primary, intended audience of many academic articles.