Joe Bower and Lynn Paine “had me at hello” (to quote Jerry Maguire) with their new HBR article, “The Error at the Heart of Corporate Leadership.” Laying out their data, they find that long-term oriented companies create more financial value and more jobs. In fact, if more American companies were focused on the long term, they estimate, investors would have an additional $1 trillion, workers would have an additional 5 million jobs, and the country would have more than an additional $1 trillion in GDP.
I agree with their vision of a future in which more companies focus on the long term and become more productive for the world (their findings accord with my own work on the dangers of short-termism). But I long for actions that go beyond admonitions to managers and boards to do better, that give both parties a better chance to stand up to capital markets players, like activist hedge funds, pressuring them to become too short-term focused. While no one thing can or will drive the transformation, there is one change that I think is doable and would make a real difference: holding-period-based voting rights.
My basic premise is that corporations need to make capital investments that take years — not months, weeks, days, minutes or seconds — to pay out. Hence they need capital that is with them for longer rather than shorter periods. One capital form is debt: a bond. Bonds give the debtor certainty over its ability to use the capital for a fixed period of time (unless there is a call provision written into them). Common equity is supposed to be even longer term – once it is given to the company, it notionally has the capital forever.
However, unlike a bond, common equity is not long-term/forever on predetermined, immutable terms. Because anybody can buy that equity on a stock market without permission of the company, buyers can fundamentally change the terms of that equity investment. An activist hedge fund, for example, can exert massive pressure to change the strategy and/or investment approach of the company based on its ownership of a sufficient share of the company’s equity.
The Refresher: Net Present Value
For the creation and deployment of strategy, long-term capital is more valuable than short-term capital, plain and simple. If you give me $100 but say that you have the right to take it back or change the pattern of its usage with 24 hours notice, it isn’t nearly as valuable to me as if you say I can use it for 10 years for the purpose for which we agree it is intended before I am allowed to assist on any change in purpose or to ask for it back.
While not fully analogous, if Singapore sovereign wealth fund Temasek holds its equities for, say, 8 years on average while quantitative arbitrage hedge fund Renaissance Technologies holds them for milliseconds at a time, the Temasek capital is more valuable than Renaissance’s. And arguably, the capital of Renaissance is more valuable than “activist hedge funds” Triac or Pershing Square who will jerk around your strategy with one thing in mind – short-term trading gains.
The fundamental difference in value to the company notwithstanding, those equity dollars invested are given exactly the same rights.
Instead, we should adopt holding-period based voting rights. Each common share should give its holder one vote per day that holder has owned the share – up to 3,650 days or 10 years. So if you hold 100 shares for 10 years, you get to vote 365,000 shares. If you sell your shares to an activist hedge fund (or anybody else), they get 100 votes the day they buy the shares. If its intention is to become a long-term holder, eventually it will get 365,000 votes. If it is Pershing Square, the interests of the investors who have provided the company with more valuable capital will swamp its influence — appropriately.
The adoption of holding-period based voting rights would provide long-term shareholders with the reward they deserve for providing the most valuable kind of capital. And it would make it extremely hard for the Pershing Square’s of the world to take over effective control of companies because the minute they acquire a share, its voting rights get reduced to a single vote. This would frustrate the “arbs” (arbitrageurs) who make their returns by buying up shares and hoping to sell to the acquirer at the time of their successful takeover bid.
Critics of this idea argue that it would simply ensconce bad management. No, it wouldn’t change investors’ incentives one iota. Currently investors sell their economic ownership of a share along with one voting right to the arbs or the activists if they are unhappy with management. Under holding-period based voting rights, they sell their economic ownership of a share along with one voting right to the arb/activist if they are unhappy with management. There is no difference whatsoever.
However, if a lot of shareholders are happy with management and the activist wants to make a quick buck by gaining enough voting control to force the company to sell assets, cut R&D investment, or anything else bad for its future, this will reduce the ability of the activist to collect enough voting rights to force management to make short-term decisions.
There is no cost to anybody other than the investors in hedge funds. For everybody else in the system, it is an improvement.