Debate Magazine

Economic Myths: Share Trading "encourages Managers to Think Long-term"

Posted on the 16 July 2015 by Markwadsworth @Mark_Wadsworth

From yesterday's City AM:
Long-term investment is critical for developing the intangible assets that are key to the success of the twenty-first century firm. Thus, locking in shareholders for the long term would seem sensible. So why did influential proxy adviser Institutional Shareholder Services, and major pension funds, vote against Toyota’s proposal [to pay higher dividends to 'long term investors'] ?
Because it’s not that simple. Short-term trading by investors need not equate to short-term behavior by managers. Instead, short-term trading can be based on a firm’s long-term value, and thus encourage managers to think long-term.

Etc etc blah blah blah.
The article claims that 'short term trading' is just as good as 'long term investment' and is all well and good, but does not address the fundamental point: how are the unearned capital gains/losses made/suffered by people who buy, hold and sell shares of any benefit to the business? Why have traded shares in the first place? What about other forms of ownership?
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For sure, every business has to be owned by somebody i.e. it starts off with a bloke or three who have a bright idea, tap their friends and family for a few bob and start up. If they don't fail, over time, some employees might take a lower salary in exchange for a higher profit share and become co-owners; they might tap a wider circle of people for cash if they need to expand and those people have to be promised a return; they might be a 'people business' which is owned by senior employees (a partnership) or an idealistic workers' co-operative etc.
These are all examples of businesses whose shares are not freely traded. Partnerships are owned by the partners; unit trusts are owned by unit holders; most limited companies are private limited companies (and most of those are run as quasi-partnerships, are family companies or are actually sole traders). More importantly, building societies are owned by depositors; the general public can easily invest in a building society by depositing money with it, there's no reason why this model can't be used for any other large business.
There is nothing to suggest that such businesses are less successful than quoted companies. If this were not true, no quoted business would ever have been 'taken private'. And instead of banks going bankrupt and building societies surviving during the recession, it would have been the other way round.
Whoever owns the business will want the best out of the employees as a whole. That includes everybody from senior managers down to the lowliest shop floor worker. In a classic partnership, every partner keeps tabs on the others; the top performers get promoted or a bigger profit share, the under-performers get demoted or booted out. If one building society offers better rates than another, then depositors will move to it.
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What is infinitely more important than the share price is that shareholders have a vote (or did, until the boys in The City arranged things to sideline small investors. They are now enticed into giving their money to 'pensions funds' who'll do the voting for them, thank you very much). And it is shareholders at general meetings who have the power to sack directors (or did until, see above).
In real life, the share price only has an indirect influence on management behaviour, and this can be malign as much as benign (i.e. cooking the books, over-gearing, doing share buy-backs).
And democratic decision making applies to all legal forms of business ownership, be it workers' co-operative, partnership, family-owned business, building society, whatever.
All these owners - however we label them - will be keen to see that they are getting the best return. If they are shareholders, they will waste oodles of time and energy tracking the share price, and if they own the business directly, they will only be looking at what really matters - current and future profits. There will always be a difference of opinion between 'workers' and 'investors' as to who deserves a bigger share of profits, but this is shades of grey, it is not a fundamental conflict of interest.
And it is output, employment and profits which really matter. As long as a business is producing something, employing somebody and creating a surplus, that is a good business (whoever owns it).
Share prices are a complete and utter irrelevance, play no part in the productive cycle and quite possibly damage it. Claiming that speculating in shares "encourages managers to think long-term" is almost as fatuous as claiming that the betting odds influence the outcome of a greyhound race. I doubt that even the maddest of mad statisticians would include changes in share prices in GDP, for example.


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