Corporate Finance
UK `Short-Termism' Refuted

At a lunchtime meeting on 5 December, Colin Mayer presented the results of a recent study on corporate performance in the UK. Mayer is Price Waterhouse Professor of Corporate Finance at the City University Business School, London, Co-Director of the Applied Microeconomics programme of the Centre for Economic Policy Research, and Chairman of the European Science Foundation Network in Financial Markets. His talk was based on his CEPR Discussion Paper No. 571, `Stock Markets and Corporate Performance: A Comparison of Quoted and Unquoted Companies' , with Ian Alexander. Financial support for the meeting was provided by the UK Economic and Social Research Council, as part of its support for the Centre's dissemination programme. The views expressed by Professor Mayer were his own, however, and not those of the ESRC nor of CEPR, which takes no institutional policy positions.
Mayer began by noting that the common assertion that stock markets have detrimental effects on long-term corporate performance which has been heard in the UK for some 100 years is supported by little economic theory and less empirical evidence. Even the debate over the `efficient markets hypothesis' remains largely unresolved despite considerable effort, and its results shed little light on the possible `short-termism' of stock markets.
Mayer reported the results of comparing the performance of the largest UK unquoted companies with that of comparable firms quoted on the London Stock Exchange, in order to obtain a direct test of the effects of such a quotation on firms' behaviour. This study measured the real and financial performance of 56 unquoted firms in the Times Top 1000, matched by size and industry to similar firms with stock market quotations.
Mayer reported that the quoted firms grew faster within industries and tended to be concentrated in the higher-growth industries. They grew more rapidly than unquoted firms in terms of employment, sales and investment; they also had higher investment ratios even when adjusted for their higher sales and higher labour productivity. Data on individual firms' R&D expenditure have not been available for long enough to allow a direct comparison, but data at the industry level indicate that quoted firms tend to be concentrated in high-technology industries (defined as those with R&D expenditures of more than 1% of aggregate industrial sales). This strongly contradicts the conventional wisdom that stock markets discourage long-term investment in R&D. In terms of financial performance, the quoted firms were more profitable than the corresponding unquoted firms whether measured in terms of profit margins on sales or rates of return on capital. Quoted companies paid out greater proportions of their earnings as dividends than their unquoted comparators; they also raised more external equity finance in gross terms; although they issued less net new equity (as a proportion of profits) as a consequence of their greater purchases of equity in acquisitions.
With the exception of investment/profit ratios, quoted firms performed better on all counts than their unquoted counterparts; UK data for the 1980s therefore provide no support for the simple `short-termist' proposition that stock markets impede corporate development and long-term investment.
Mayer noted several reasons for caution in interpreting this result, however. The 1980s was an unusual period, in which a high proportion of firms' growth was due to acquisitions, and quoted firms engaged in far more acquisitions activity than similar unquoted firms. Much of this growth may have been achieved at the expense of other firms, and even the threat of take-over may have impeded the growth of smaller, more vulnerable firms. Quoted firms' stronger performance may reflect a failure of the UK financial system in promoting unquoted firms, which are therefore `forced' to seek stock market listings in order to grow beyond a certain size. The main deficiency of the UK financial system may therefore be not that it impedes the growth of quoted firms, but rather that it discourages the growth of comparable unquoted firms.
Mayer suggested in conclusion that alternative institutional arrangements may do better at the economy-wide level for quoted and unquoted firms alike. For example, Germany has many more large unquoted companies than the UK, and these can grow without seeking stock market quotations. They enjoy closer relationships with their banks; fewer firms are listed on Continental stock markets than on the London Stock Exchange; and there is a greater incidence of `cross-shareholdings' among those that are listed, so they are much less vulnerable to outside control. This suggests that a more complex version of the `short-termist' proposition may still apply to the UK stock market, if it can be shown that different institutional arrangements serve other countries' corporate sectors better.