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The Macro Impact of Short-Termism

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  • Stephen J. Terry

    (Stanford University)

Abstract

There is a long concern in economics that investor pressure can induce managerial short-termism, which I examine through the lens of analyst earnings targets. Managers face a tradeoff between short-run profits and long-run investment. This paper starts empirically by showing that firms that just meet earnings targets lower their investment in R&D and intangibles. Firms that just miss their earnings targets cut CEO pay and face drops in stock-market valuation. The paper then builds and structurally estimates a quantitative general equilibrium endogenous growth model with heterogeneous firms, R&D and accounting manipulation choices, and endogenous earnings forecasts. In the model, the short-run pressure to meet earnings forecasts cuts growth because R&D is misallocated across firms, responding too much to short-run profit shocks. This effect cuts growth rates by almost 0.1%, costing the US economy around 6% of output each century. Extending the model to include managerial shirking and empire-building reveals that earnings targets can improve firm value but may still reduce long-run growth and consumer welfare.

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  • Stephen J. Terry, 2015. "The Macro Impact of Short-Termism," Discussion Papers 15-022, Stanford Institute for Economic Policy Research.
    • Handle: RePEc:sip:dpaper:15-022
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    Cited by:

    1. Stephen Terry & Anastasia Zakolyukina & Toni Whited, 2018. "Information Distortion, R&D, and Growth," 2018 Meeting Papers 217, Society for Economic Dynamics.
    2. Stephen J. Terry & Toni M. Whited & Anastasia A. Zakolyukina, 2020. "Information versus Investment," Working Papers 2020-110, Becker Friedman Institute for Research In Economics.
    3. Miettinen, Topi & Stenbacka, Rune, 2018. "Strategic short-termism: Implications for the management and acquisition of customer relationships," Journal of Economic Behavior & Organization, Elsevier, vol. 153(C), pages 200-222.
    4. Fromenteau, Philippe & Schymik, Jan & Tscheke, Jan, 2016. "Import Competition and the Composition of Firm Investments," Discussion Papers in Economics 29654, University of Munich, Department of Economics.
    5. Christine L. Exley & Stephen J. Terry, 2015. "Wage Elasticities in Working and Volunteering: The Role of Reference Points in a Laboratory Study," Harvard Business School Working Papers 16-062, Harvard Business School, revised Jun 2017.
    6. Pinchetti, Marco, 2020. "What Is Driving The TFP Slowdown? Insights From a Schumpeterian DSGE Model," MPRA Paper 98316, University Library of Munich, Germany.

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    Keywords

    Short-Termism; Earnings Manipulation; Heterogeneous Agents; Endogenous Growth; Agency Conflicts; Shirking; Empire Building.;
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