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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.

Suggested Citation

  • 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. repec:eee:jeborg:v:153:y:2018:i:c:p:200-222 is not listed on IDEAS
    2. 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.

    More about this item

    Keywords

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

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