Are companies too focused on quarterly earnings at the expense of long-term strategy? According to new research from the University of Maryland’s Robert H. Smith School of Business, the answer is a resounding “yes.”
Maryland Smith professor Rachelle C. Sampson, working with Smith PhD graduate Yuan Shi, now at Cornell University, looked at what’s called short-termism, or quarterly capitalism. It’s what happens when companies focus on returning money to shareholders each quarter, rather than spending money on productivity improvements or on research and development for their next big innovation. And it’s dragging down the U.S. economy, but also pumping up equity portfolios, says Sampson.
In the study, now published in Strategic Management Journal, Sampson and Shi apply a new quantitative measure to definitely show that U.S. capital marketing have become increasingly short-term oriented in recent decades – answering a question long debated by managers, researchers, investors and policymakers. The researchers looked at firms listed on major U.S. stock exchanges from 1980 to 2013.
They calculated an implied discount rate for firms, which quantifies how much investors are discounting a firm’s future expected cash flows. The researchers found a strong link between the implied discount rate and a firm’s short-term-oriented behavior.
They found firms were becoming more short-term oriented, on average, across the market, with the trend showing up in the vast majority of individual firms. Just how short-term oriented a firm is relates to several factors, say the researchers, including the patience of investors, the types of investments the firm makes, the way CEOs are compensated and external pressures, such as activist investors and market analysts.
Sampson and Shi suggest some drivers of this change.
“Some potential explanations include rising exposure to globalization and the increasing pace of technological change that may make firms more impatient for returns and less willing to take on the risks associated with longer‐term investments,” they write.
Publicly traded companies are under increasing pressure from shareholders to deliver short-term returns, rather than planning for long-term success. A shortening time horizon dampens future sources of market and productivity growth, depresses wage growth and stunts economy-wide progress.
If firms focus only on the short-term, their strategic decisions may not be aligned with their long-term interests, say the researchers. They risk ignoring areas that can create value over the long-term - sustainable supply chains, research and development, capital projects, employee training, and other longer-term initiatives.
The implications for the wider economy are stark.
"It’s fair to say that a short-term perspective has the potential to undermine the traditional growth engines of the American economy, and bankrupt our future," Sampson says.
Sampson and Shi hope the evidence documented in their study can help firms better understand short-termism in organizations and use that to develop more effective long-term strategies.
Read the full research, “Are U.S. firms becoming more short‐term oriented? Evidence of shifting firm time horizons from implied discount rates, 1980–2013,” in Strategic Management Journal.
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