Corporate short-termism

A long-standing debate concerns whether corporations are becoming short-termist (Hayes and Abernathy, 1979). Corporate short-termism is usually understood as firms’ actions motivated by an excessive focus on their short-run objectives, such as boosting current profits at the expense of the long run investment in research and development or capital expenditures. Investors’ pressure to meet quarterly earning forecasts, ineffective corporate governance and CEO pay packages that reward short-term performance are often cited as factors that induce corporate short-termism. Advocates of the view that firms are being short-termist emphasize that such behavior not only destroys shareholder value and causes financial instability, but also impedes inclusive prosperity by harming long-term growth (Summers and Balls, 2015). In an attempt to reduce firms’ apparent focus on the short run, in 2018 U.S. President Trump commissioned the Security and ExchangeCommission to evaluate the possibility of decreasing the required financial reporting frequency from quarterly to semiannual. In contrast, skeptics of the short-termist view underscore that R&D has grown steadily over the past 40 years, that corporate profits in modern economies are currently near historical highs, and that investors routinely fund new pharmaceutical and technological companies that endure heavy losses for years before they start generating profits, if any, in the long run. Furthermore, Steven Kaplan argues that if the public corporate sector were under-investing in innovation and in the long-run, substantial investment opportunities would exist instead for venture capital and private equity firms. The fact that returns by VC and PE firms are low is inconsistent with the possibility that profitable long-term investment opportunities exist (Kaplan, 2018).The objective of this research project is to develop a micro-funded economic model to quantify corporate short-termism at the individual firm level. The model intends to capture the basic trade-off between exerting short-term effort and investing for the long-run, and at the same time deliver tractable solutions of optimal corporate polices that can be estimated using real data. Recent dynamic models proposed by Hackbarth et al. (2018) and Gryglewicz et al. (2020) can provide the backdrop for developing such a flexible, yet tractable model. The model will be used to address endogeneity concerns about corporate policies, to disentangle optimal short- and long-term efforts, and more generally to guide empirical work. In contrast to extant empirical work that mostly relies on proxies of corporate short-termism, we aim to estimate micro-funded measures of it. One advantage of our approach is that we can quantify the economic magnitude of short-termism, not just its qualitative behavior. Recent joint work by the applicants can be extended to measure corporate short-termism. Gryglewicz, Mancini, Morellec, Schroth, and Valta (2021) have introduced a novel approach to identify short- and long-term shocks in corporate cash flows. In addition, Frésard, Mancini, Schroth, and Sinno (2021) have extended that approach to disentangle corporate short- and long-term efforts, silent about possible conflicts or biases influencing these choices. This project will build on these methods and add an explicit formulation of how much short-term effort is optimal or excessive.The project objective is topical. The empirical results can inform the current policy debate about how to sustain long-term growth. The estimates of the model can also inform about the resilience of firm growth to severe short-term shocks as a function of the firm’s short-term v. long-term chosen efforts. This task now appears very important in the aftermath of the Covid-19 pandemic. In addition, the project output can be informative about the tensions between shareholders and stakeholders, whether they are worsening or not, and whether factors like ownership concentration, market pressure or management compensation impact corporate short-termism.