In July 2020, the European Commission published the ‘Study on directors’ duties and sustainable corporate governance’ by EY (‘the Report’). The Report purports to find evidence of debilitating short-termism in EU corporate governance and recommends many changes to support sustainable corporate governance. The Report’s evidence and analysis are deeply flawed. We recently submitted a dissection of these flaws to the Commission’s call for feedback, and we make it available on SSRN here. In this post, we summarize our argument.
The Report’s main flaws are:
- Its definition of the problem. The Report conflates time-horizon problems (short-termism)—which are the focus of its evidence collection—with externalities and distributional concerns. Cures for one are not cures for the others and a cure for one may well exacerbate the others. The difference is also critical for assessing the EU’s ability to act under the principle of subsidiarity.
- Inapposite evidence. The Report’s main ostensible evidence for an increase in short-termism, presented in its section 3.1, is rising gross payouts to shareholders (dividends and repurchases) coupled with declining investment (as measured by accounting measures of CAPEX and R&D) at certain large listed companies. However, (a) the more relevant measure to assess corporations’ ability to fund long-term investment is net payouts (ie, gross payouts minus equity issuances), which are much lower than gross payouts, have risen but only by recovering from earlier unsustainably low levels, while still leaving plenty of funds available for investment, and (b) the Report oddly fails to use a full sample of EU listed companies, an analysis of which shows that CAPEX and R&D actually increased over the time period considered in the Report.
- Biased use of literature. The Report selectively cites, and focuses only on the parts of, academic studies that support its views, while failing to engage substantial contrary literature. For example, the Report discusses studies detecting short-termism, but fails to mention major studies failing to detect short-termism or studies showing excessive long-termism. Nor does the Report acknowledge that the academic empirical literature is divided on whether short-termism, if present, is severe and that conceptually short-termism is quite plausibly a modest, unfortunate but inevitable side-effect of effective corporate governance, rather than a first-order problem warranting wholesale reform.
- Ill-considered reform proposals. Having failed to analyze the problems properly—or, for short-termism, even to demonstrate that a substantial time-horizon problem exists—the Report touts multiple cures that can at best be described as hopeful: there is no strong evidence that any of them work as intended. For those cures that have been studied in the academic literature, the available evidence gives rise to considerable skepticism that they are effective, and some appear to be counterproductive. The Report does not examine any of this evidence.
The Commission already repeated some of these flaws in its Inception Impact Assessment. We can only hope that the negative feedback from us and many others will convince the Commission to start afresh.
Mark J Roe is the David Berg Professor of Law at Harvard Law School.
Holger Spamann is the Lawrence R. Grove Professor of Law at Harvard Law School.
Jesse Fried is the Dane Professor of Law at Harvard Law School.
Charles Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration at Harvard Business School.
This post is part of the new OBLB series: ‘European Commission Initiative on Directors' Duties and Sustainable Corporate Governance’.