Strong Managers, Weak Owners: The Political Roots of American Corporate Finance

By Mark J. Roe | Go to book overview

CHAPTER 18
Short-Term Finance as the Problem?

THUS FAR we have treated managers as the problem and enhanced institutional voice as a possible solution. But maybe managers are doing just fine, but institutions are the problem. And perhaps concentrated ownership is a partial solution to the institutional problem.

Managers complain that the short-term bias of a stock market of furious traders makes it hard for managers to concentrate on the long term. Hence, managers must spurn the long term and underinvest in building up their organizations and their employees. While this sounds true to many, it has theoretical problems. Even furiously trading shareholders include buyers as well as sellers. Buyers are interested in what price they will get for their stock when they sell it. So, today's buyer is interested in what tomorrow's buyer will pay, who is interested in what the next day's buyer will pay, and so on. Since each buyer is dependent on the price to be garnered in some distant long run, each buyer is interested in the longrun price, even if he or she will not be the long-run owner. There must be something more complex to support the short-term argument than furious trading alone.

And there is one, at least in theory, tied to fragmented ownership. Information does not always flow costlessly and accurately from inside the firm to the firm's stockholders. When information is complex, proprietary, or “soft” (i.e., difficult to quantify), the insiders in the firm can understand it, yet be unable to explain it to the outsiders. Stockholders with small holdings cannot spend much in understanding complex, technological information, so they might ignore it. And managers with good but proprietary information would not want to reveal it to the stock market, and consequently to competitors, so the stock market never gets it.

That is, what if there are economies of scale in getting the information and judgment needed to accurately assess a firm's long-term outlook, because accuracy requires staff, expertise, and time spent inside the boardroom? If so, a large holding might be needed to spread the information costs.

Moreover, what if analytic evaluation required personal evaluation, from confidential conversations in the boardroom? Large blocks of stock would facilitate the flow of soft, technological information from the firm to the large blockholder. If securities analysts sometimes undervalue longterm research and development when they cannot understand it, then so

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