Problem for corporate decision

Is ‘short-termism’ a serious problem for corporate decision making? You may refer to companies in any country you think is interesting. (approximately 1250 words) The last several decades have witnessed series of serious corporate failures as a result of ‘short-termism’ and its corrosive effect on corporate decision making. Although many firms acknowledge that ‘short-termism’ may hinder them from focusing on their long-term objectives, they do nothing but neglect its effect.

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All they care about are short-horizon profits though these may hurt them in the long run. This essay will argue how serious the problem is by having a look at the collapse of the ‘dot-com bubble’ in the early part of this decade. ‘Short-termism’ is usually defined as ‘the excessive focus of some corporate leaders, investors, and analysts on short-term quarterly earnings and a lack of attention to the strategy, fundamentals and conventional approaches to long-term value creation’ (Krehmeyer D et al 2006: 3).

This phenomenon is mainly attributed to institutional investors, e. g. pension funds and mutual funds, who are undoubtedly short-run seekers, given that they constitute an increasingly monitoring role in corporate governance. In addition, they rarely equip themselves with the industrial knowledge to engage in the long-term development of a company, nor are they willing to take on such a role (Esbjorn Segelod 2000: 244). Corporate managers, under the pressure of their institutional investors, in turn, will likely carry out short-horizon investment.

Other contributing factors to myopic behaviours are possibly political uncertainty, doubts about market growth and high economic inflation rates. The most obvious manifestation of short-termist behaviour is ‘excessive focus on quarterly earnings guidance which results in the wide-spread use of the discounting cash flow technique in connection to excessive hurdle rates and short-time horizons, thereby favouring cost reduction and causing a bias against new technology and basic investments’ (R. H. Hayes et al 1982: 70-79 cited in Esbjorn Segelod 2000: 244).

The most serious effect of ‘short-termism’ on corporate decision making is the overwhelming readiness of corporate managers to decrease discretionary spending in such critical areas as research and development, advertising, hiring and training in order to meet their short-term earning targets (John R. Graham et al 2005: 32-36). In fact, extra sales volumes could be generated by lowering product price when the cutting of discretionary expenditures is carried out; however, this implicates the potential adverse longer-term consequences.

The choice between growth-maximizing, profit-maximising and shareholder value-maximizing objectives is always controversial issue for many firms. Nevertheless, in reality, when managers are given the alternative of short-term earnings or total cash flow, they are prone to the first one notwithstanding that this alternative may be sup-optimal over the long term. In other words, long-term strategic projects tend to be neglected even though the creation of long-term value is commonly accepted as one of a manager’s fundamental responsibilities.

(J B Coates et al 1996: 32; Krehmeyer D et al, 2006: 3) The other misguidance of ‘short-termism’ is that managers tend to pursue short-term investments when they are given high incentives to perform in the short-run, which ‘largely come in the form of increased fund inflow and asset under management on the upside, and firing on the downside’ (Lijin 2005: 4). As revealed in the result of the CFO survey conducted by Duke University, nearly 90% of respondents admit that their business decisions are often based on tenure considerations (Louis M.

Thompson, Jr. 2007). Consequently, asset prices will likely be affected by inflating the price of the most liquid assets, and dampening the price of long-term illiquid assets. Such critical long-term oriented areas as research and development are likely to be ignored because they are less liquid, and hence their prices could deviate even further from their fundamental values, even if they promise to earn high risk adjusted return on capital (RAROC) and real value in the long- term.

(Lijin 2005: 4-5) More seriously, the obsession of near-term quarterly earnings results in a possible damage of longer-term corporate growth. The abuse of short-run financial performance measurements such as earnings per share (EPS), return on investment (ROI), return on capital employed (ROCE), and return on equity (ROE) takes the focus of managers away from long-term performance measurement and shareholder value.

(J B Coates et al 1996: 32) Quarterly reports and financial forecasts may be manipulated, in so-called “accounting shenanigans”, to meet corporate earning projections. This action gives an illusion of complete business predictability and misleads their shareholders. To make matters worse, the pressure to meet short-term quarterly earnings numbers can cause unexpected market volatility. This may, in turn, cause management to lose sight of its strategic business model and endanger its global competitiveness. (Matteo Tonello 2006)