Notes on economic short-termism
Short-termism is the excessive focus on short-term results to the detriment of long-term interests. It is widely assumed that companies are economically focused on short-termism, since they want to maximize earnings. I have found data all over the map on this idea.
It has been widely accepted that corporations often adopt short term strategies that attempt to maximize earnings. As one well cited survey of financial executive explained, “Because of the severe market reaction to missing an earnings target, we find that firms are willing to sacrifice economic value in order to meet a short-run earnings target.”
This preference for the near term, especially for payoffs in the near term, seems to be a common feature among humans. People tend to prefer small rewards that occur now over much larger rewards that come later. This is known as hyperbolic discounting and it helps to explain why households under-save, why smokers find it tough to quit, and why firms prefer near term earnings.
Pulling together the insights from finance and behavioral psychology, two economists pointed out “that a firm exhibiting hyperbolic discounting preferences faces an underinvestment problem, i.e. there exists another feasible investment plan that improves all periods' present values.” Conversely, a firm exhibiting time invariant preferences would invest, even if it meant a short term hit.
Facebook is probably playing the long game. Zuckerberg has an overwhelming controlling stake in the company and wants to build value in the long term. And if these changes lead to more durability, that is, if users stay on the site longer in the next 5 or 10 years, then it makes sense to take the short term hit. It would be better to do this than have a massive exodus at some point down the road.
In the same kind of way, Amazon has been criticized for years for spending too much money on company investments to the detriment of returns. But, Amazon’s Q2 2018 numbers came in this week and they were double expectations. Bezos' 1997 shareholder letter laid out the strategy, “We believe that a fundamental measure of our success will be the shareholder value we create over the long term.” Bezos is also more concerned with building for the long term.
I have found some other research since first posting that piece that speaks to long-termism.
From a 2015 Google study: “This and similar ads blindness studies led to a sequence of launches that decreased the search ad load on Google’s mobile traffic by 50%, resulting in dramatic gains in user experience metrics. We estimated that the positive user response would be so great that the long-term revenue change would be a net positive.”
“Long Term Bias” by Michal Barzuza and Eric L. Talley; Abstract: “An emerging consensus in certain legal, business, and scholarly communities maintains that corporate managers are pressured unduly into chasing shortterm gains at the expense of superior long-term prospects. The forces inducing managerial myopia are easy to spot, typically embodied by activist hedge funds and Wall Street gadflies with outsized appetites for next quarter’s earnings. Warnings about the dangers of “short termism” have become so well established, in fact, that they are now driving changes to mainstream practice, as courts, regulators and practitioners fashion legal and transactional constraints designed to insulate firms and managers from the influence of investor short-termism. This Article draws on academic research and a series of case studies to advance the thesis that the emergent folk wisdom about short-termism is incomplete. A growing literature in behavioral finance and psychology now provides sound reasons to conclude that corporate managers often fall prey to long-term bias—excessive optimism about their own long-term projects. We illustrate several plausible instantiations of such biases using case studies from three prominent companies where managers have arguably succumbed to a form of “long-termism” in their own corporate stewardship. Unchecked, long-termism can impose substantial costs on investors that are every bit as damaging as short-termism. Moreover, we argue that long-term managerial bias sheds considerable light on the paradox of why short-termism evidently persists among supposedly sophisticated financial market participants: Shareholder activism—even if unambiguously myopic—can provide a symbiotic counter-ballast against managerial long-termism. Without a more definitive understanding of the interaction between short- and long-term biases, then, policymakers should be cautious about embracing reforms that focus solely on half of the problem.”
First published May 12, 2021