Short-Termism: Don’t Blame Investors

Executives often complain that investors’ obsession with short-term performance forces them to make decisions that hurt long-term returns. But our research shows that it also works the other way around: Executives with a short-term orientation attract investors who are fixated on quarterly numbers. To assess the orientations of senior managers, we analyzed the transcripts of 70,042 earnings conference calls held by 3,613 firms from 2002 to 2008. We counted up words and phrases that suggest a short-term emphasis (“next quarter” and “the latter half of this year,” for example) and ones that point to a long-term view (“years” and “long run”). To determine whether this measure of language was consistent over time, we ranked companies’ short-termism on the basis of their 2002 calls and compared the results from subsequent years, finding that more than 80% of firms remained in their original quartile. This suggests that short-termism is rooted in a company’s culture. Different Businesses, Different Time Frames An analysis of earnings calls reveals that certain industries tend toward particular horizons. Short Term Banking Business Services Business Supplies Computers Electronics Energy Insurance Railroad Equipment Shipbuilding Trading Long Term Apparel Beverages Cars and Trucks Consumer Goods Construction Defense Medical Equipment Pharmaceuticals Recreation Utilities To test whether our keyword measures were actually a proxy for managerial horizons, we then examined how frequently the firms that used short-term language engaged in earnings management—a behavior that signals a focus on short-term metrics. Indeed, those companies were likelier than others to manage earnings: They had higher absolute discretionary accruals, were apt to have very small positive earnings or to barely beat analyst forecasts, and often made cuts in R&D in years when they reported small earnings or just met or slightly beat forecasts. When we looked at the shareholder composition of those firms, we found many more “transient” than “dedicated” investors. One might argue that the high proportion of transient investors is purely a cause of companies’ short-term focus, not a result of it. However, after examining company characteristics, such as board demographics, that most likely influence companies’ but not investors’ horizons, we concluded that although short-termism may be fueled by investor pressure, it’s equally true that investors select companies for their time frames. Our study also documented the common assertion that a short-term focus carries costs. The stock of companies exhibiting short-term behavior was more volatile than the market as a whole, and the cost of capital for those firms was 0.42% higher than average. For all the commentary in recent years about short-termism, many broad questions about the phenomenon have yet to be explored. For instance, although critics assert that managerial short-termism hurts companies’ innovation efforts, there’s no empirical evidence to support the claim. Nor do we know whether exposure to different kinds of capital markets promotes short-term thinking—consider the shift toward debt financing that’s been prompted by leveraged buyouts. But one thing we do know is that short-term tendencies in the capital markets are not insurmountable: Managers can take actions and structure their communications to offset them. They should be aware that to a large degree, they are setting the tone. The language a company uses when talking to investors is a meaningful indicator of its orientation—and the investors listening in on calls that emphasize a short-term approach are a largely self-selecting group who like what they hear.

Short-Termism: Don’t Blame Investors

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