crime prevention-corp gover (final)
TRANSCRIPT
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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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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism
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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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism
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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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism
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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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism
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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Analysis of the UK stock Market:Duress as an Extenuating Factor of Short-Termism
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