The Long and Short of Corporate Governance

A movement is growing among commentators in the academy, the bench, and the bar that sees short-term shareholders — especially activist institutional shareholders — as a threat to the long-term best interests of publicly traded corporations. These “long-and-short” commentators argue that institutions with short investment horizons tend to favor short-term corporate governance gimmicks that temporarily “pump up” stock prices but depress corporate value in the long run. As a remedy, they propose that activist institutional shareholders need an accountability mechanism, such as fiduciary duties applicable to officers and directors in corporate law. The argument's intuitive mantra — that short-term investment horizon leads to short-term governance — has received considerable purchase among the bench and bar. However, the simple seemingly intuitive connection between short investment horizon and governance horizon is not at all clear when one digs beneath the surface of the assertion. Finance theory would suggest that differences between short-term and long-term value would be quickly eliminated by arbitrage activity. To the extent that there are limits to arbitrage, these limits are unlikely to apply to the type of activism pushed by institutional investors, such as corporate governance reforms. In all, the short-termism perspective developed in law reviews lacks even a plausible basis in any mainstream work in finance, whether classical or behavioral.In addition, the long-and-short argument is fundamentally incompatible with bedrock principles of corporate law. Recognizing a distinction between the interests of short-term and long-term shareholders would make even ordinary board decisions involve a conflict of interest and therefore subject to entire fairness review rather than the business judgment rule. Such a change would mean paralysis in corporate affairs, as virtually every decision could be challenged in court. This Article predicts that the “investment horizon” debate portends a coming collision of interests that will have dramatic implications for the corporate landscape, including the possible demise of Delaware as corporate jurisdiction of choice