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 European corporate governance has received much less attention. On 30 May 2023, the University of Antwerp, Harvard Law School and the European Corporate Governance Institute (ECGI) organized a conference that tried to address this by focusing on short-termism in Europe. Focusing on European corporate governance is important, because it differs in important respects from corporate governance in the US and the UK, for example because much more listed corporations in Europe have a controlling shareholder.

At the conference, I argued that the presence of a controlling shareholder can have an important impact on corporate short-termism, regardless of what you believe is at the source of short-termism. First, short-termism could arise from short-termist institutional investors and asset managers, whose short-termism is transmitted to managers. For example, short-termist institutional investors and asset managers could vote in support of short-term based executive compensation or short-termist shareholder activists. I call this “investor short-termism”.

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

Second, short-termism could also arise if managers and directors are inherently short-termist. For example, managers may want to demonstrate good results during their tenure at the corporation, in order 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 that they are actually 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. On the other hand, controlling shareholders may also enjoy private benefits of control. Because some private benefits of control cannot be transferred easily, controlling shareholders may be “locked in” and forced to think of the long-term cash flows of the corporation. For example, a family shareholder may enjoy private benefits from keeping control over the corporation within the family. However, private benefits of control may also incentivize controlling shareholders to act in a short-termist manner. For example, a family controlling shareholder may prioritize the short-term liquidity needs of the family 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 we believe that controlling shareholders are generally more long-term oriented (which is debatable), we 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 is that the wedge between cash flow rights and control also increases the risk of the extraction of private benefits, which could be a source of short-termism. Ironically, it is precisely the tool that aims to encourage more long-term oriented controlling shareholders that can cause controlling shareholders to become more short-term oriented. Initiatives to facilitate controlling shareholders through multiple voting rights must therefore be accompanied by mechanisms that protect minority shareholders, such as approval 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.

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Tom Vos is a full-time visiting professor and researcher at the Jean-Pierre Blumberg Chair at the University of Antwerp (Belgium), and a part-time attorney at Linklaters LLP (Belgium).

This blogpost is based on a recent working paper of the author, available on SSRN.

If you would like to read further articles in the 'Short-Termism Special Issue' series, click here

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