Debunking the short-termist thesis in financialization studies: Evidence from US non-financial corporations 1998 – 2018

By Niall Reddy, Joel Rabinovich

PKES Working Paper 2227

December 2022

It’s widely argued that shareholder value orientation (SVO) causes firms to adopt a financialized business model, in which short-run share prices are prioritized over the firm’s long-run growth. Financialized business models entail a “downsizing and distributing” allocation regime – the channeling of resources to shareholder payouts over reinvestment – and other changes that undermine firm’s ability to innovate, reduce costs and retain market share, harming its competitiveness. We test this theory by examining how increased shareholder power and realigned managerial preferences – two underlying ‘mechanisms’ of SVO – affect two sets of outcomes: allocation regime (fixed investment, R&D expenditure and payouts) and real performance (productivity, market share and profitability). We allow for the fact that institutional shareholders likely vary in their preferences for governance, meaning that broad objective of maximizing shareholder profit may conduce highly varying business strategies. Our findings suggest that short-termism is not an outcome common to shareholder primacy in general, but rather governance directed to certain kinds of shareholders – in particular low-turnover, non-passive institutional investors. Moreover it is much more likely to occur when those investors are empowered within the firm rather than reliant solely on managerial reincentivization. This suggests short-termism is a more contingent feature of NFC financialization than commonly supposed.

Keywords: financialization, corporate governance, firm strategy, short-termism

JEL classification: G30 L20