Maybe Companies Aren't Too Focused on the Short Term
Hillary Clinton thinks U.S. corporations live for the short-term, obsessing over the next quarterly earnings statement to the neglect of their longer-run prospects. That’s a common criticism and the evidence to support it includes testimonials by corporate chief executives, a variety of corporate scandals and high and rising corporate discount rates on future cash flows. Still, it’s not been established that American corporations are on average more short-term in their thinking than they ought to be.
Perhaps most importantly, it is often easier and better to plan for the shorter term. In information technology, the average life of a corporate asset is about six years, in health care it is about 11 years, and for consumer products it runs about 12 to 15. Very often it is hard for a company to plan its operations beyond those time periods, as the U.S. economy is no longer based on durable manufacturing machines. Production has shifted toward service sectors with relatively short asset lives, and that may call for a shorter-term orientation in response.
Companies often see their short-term problems staring them in the face -- think of the need to fire an incompetent manager or lease more office space. It is harder to predict the market 20 years hence, especially when information technology is involved, and thus planning so far out can involve a lot of expense and risk.
Plenty of companies have made big mistakes from thinking too big and too long-term; for instance, a lot of mergers were based on notions of long-run synergies that never materialized. In reality, short-term improvements are often the best way to get to a good long-run plan.
Sometimes, in my university, we have discussions about where higher education is headed in 30 years or so. Those discussions are entertaining, and they may inform some longer-term decisions, such as whether to hire more tenured faculty or more adjuncts. But most of the useful improvements come from bettering the here and now, such as spreading a new teaching technique or improving services for disabled students.
Equity markets do not seem to neglect the longer run. Amazon has a high share price even though its earnings reports have usually failed to show a profit. Possibly the market judgment is wrong, but it’s hardly the case that investors are ignoring the long-run prospects of the company.
Many tech startups have high valuations even though revenue is zero or low. Again, those judgments may or may not be correct, but clearly investors are trying to estimate longer-run prospects. During the dot-com bubble of the 1990s, there was too much long-run, pie-in-the-sky thinking and not enough focus on the concrete present.
Economics Nobel Laureate Eugene Fama once said, “In hindsight, every price is wrong.” With electric and driverless cars, investors are thinking long and hard about what the future might look like and investing in equities accordingly, with share prices to be revised as events develop. If the long-run thinking of the market were systematically defective, it would be possible to profit simply through superior patience. But it is not an easy matter to see further than others.
I don’t think economists have a good standard yet for judging whether corporate decisions are too long-term or too short-term. There are anecdotes pointing in all directions, and it has not been shown that corporate time-horizon decisions are major factors driving changes in stock prices.
Don’t forget that compensation schemes for managers are more complex and more varied than in the past. Companies work hard to get the best contracts for their managers, including the appropriate long-term orientation. I don’t think we should just assume markets get it right, but we also should be wary of the difficulty of establishing a firm outside standard showing that they are so badly wrong.
If public shareholders are placing too much short-term pressure on their companies for a good quarterly earnings report, companies have the option of boosting their value by going private, as has been the trend. By 2012, the number of U.S. public corporations was less than half what it had been in 1997, in part because many companies went private. This is possible evidence that there have been problems with corporate short-termism, but on the other hand it shows that a market response is possible. Good governance is a scarce resource, and it may be that markets concentrate it in the places that need it most.
Charges of excess corporate short-termism should be taken seriously, but this criticism is not yet established as true, and it runs the risk of being another piece of conventional wisdom that doesn’t quite pan out. Dare I suggest that we look to the long term to wait and see?
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