[OP-ED]: Is corporate ‘short-termism’ a myth?
You’ve heard the criticism. Too many American corporate managers are addicted to “short-termism.” They postpone investments and other costs, sacrificing future performance for present profitability. Either they’re pressured by “activist investors” or want to inflate the value of their stock options. If true, it could help explain the economy’s lackluster performance. Now, a new study asserts that it is true.
The study is intriguing -- but be skeptical; it has some glaring weaknesses.
The study comes from the McKinsey Global Institute, the research arm of the management consulting firm of the same name. It examined the performance of 615 large- and medium-sized firms and, by various criteria, classified them as long-term or short-term companies. The corporations with a long-term outlook consistently outperformed firms with a short-term perspective.
-- From 2001 to 2014, revenues at the “long-term” firms grew 47 percent more than at the other firms.
-- By 2014, these firms spent nearly 50 percent more on research and development than did other firms.
-- Their stock prices rose more -- on average $7 billion more than the other firms.
-- They hired more people -- 12,000 more on average than the other firms.
Although the companies with a long-term perspective were more successful, McKinsey says, the pressures for short-termism are rising. In one survey of executives and corporate directors, 87 percent said they “feel most pressured to demonstrate strong financial performance within two years or less.”
What’s most interesting about the study is its formula for deciding whether firms had a short-term or long-term management outlook. It chose five company indicators, including investment, profits, and revenue growth. For example, companies that invested more were deemed more future oriented. The results were then merged into an overall index.
All this sounds scientific, but it isn’t. The study’s biggest flaw is that it mistakes differences among industries -- especially whether they’re new and fast-growing or mature and slow-growing -- for differences in management outlook. It stands to reason that many younger industries have higher investment rates than older firms with well-established markets.
Indeed, this is exactly what the study discovered: “Our findings suggest that as of 2015, idea-intensive industries such as software and biotechnology are among the most long-term, while capital-intensive industries such as automobiles and chemicals are the most short-term.”
To be sure, some executives must be compulsively short-term. The question is how widespread they are. The stock market suggests: less than you think. If short-termism were as common as many critics claim, stock prices would collapse at some point, because no one would have prepared for the future. Corporate profitability would plunge. That obviously hasn’t happened.
It’s true that corporate investment has lagged in this recovery, and this has sometimes been attributed to short-termism. A more likely explanation is that many executives didn’t see a need for more factories and shopping centers. There simply wasn’t the demand to justify more supply. From 2007 and 2016, annual business spending on new buildings, corrected for inflation, actually dropped 14 percent, according to data from the Bureau of Economic Analysis. Over the same period, spending on equipment (computers, machinery) rose only 16 percent.
By contrast, business spending that was more future-oriented increased more rapidly. Spending on software, again corrected for inflation, was up 43 percent over this period, while private R&D spending rose 26 percent.
The trouble with investing in the future is that no one knows what the future holds. When the business climate is exceptionally uncertain, there’s a natural inclination to hold back. Whatever ails the U.S. economy, it’s a lot more complicated than selfish short-termism.