Profs. Francois Brochet and George Serafeim of Harvard Business School, in a HBS Working Knowledge interview with Sean Silverthorne, Editor-in-Chief, HBSWK, talk about their new research findings that prove how management based on short-term goals have negative implications for both investors and company executives alike
Companies that manage for short-term gain rather than long-term growth have been blamed for everything from popularising celebrity CEOs to causing a significant chunk of the current financial crisis. New research findings suggest that short-termism might have negative effects on these companies themselves and their investors. There’s another surprise in the research: short-termism might not be as widespread as we think, and a substantial number of corporations are rising to the challenge. “One important takeaway is that firms with long-term horizons exist,” says George Serafeim, Asst. Professor at Harvard Business School, coauthor of the working paper ‘Short-termism, Investor Clientele, and Firm Risk’, with HBS doctoral candidate Maria Loumioti and Assistant Professor Francois Brochet. “Many companies are being managed for the long term,” says Serafeim.
The research team was interested in several issues: Do short-term companies attract a particular kind of investor? Is investing in these firms riskier than investing in companies with longer-term time horizons?
Their first order of business was to determine a method for categorising companies on the short-term/long-term continuum. The answer came in the very words used by executives to discuss their companies. Brochet, Serafeim, and Loumioti studied transcripts of 70,042 earnings calls where executives discuss quarterly results with investors, analysts, and the media that were held by 3,613 firms during 2002-2008. This involved searching for 14 terms used by management such as “latter half” and “weeks” that would tip off a short-term view, versus 15 words or phrases such as “long term” and “years” that would suggest a longer time horizon approach.
The researchers then compared their list of companies on both ends of the spectrum with the companies’ actual financial and stock performance, studying indicators such as return volatility, the length of time investors held a firm’s stock, and the cost of capital. The results showed that short-term companies attracted short-term investors (bringing with them a whole new set of performance pressures on executives) and that the financial and strategic performance of these companies was more volatile – and riskier – than that of the long-termers. The team also identified industries that appear to be short-term-oriented (banking, electronic equipment, business services, and wholesale) and long-term-focused (beverages, retail, pharma, and medical goods). Companies, too, were categorised by outlook. Short-termers included Cisco, Goldman Sachs, and Chevron, while the longer horizon outfits included Coca-Cola, Ford, and Nordstrom.
Question: In general, what relationship did you find between companies you identified as short-term-oriented, their investors, and the behaviour of their stocks?
Companies that manage for short-term gain rather than long-term growth have been blamed for everything from popularising celebrity CEOs to causing a significant chunk of the current financial crisis. New research findings suggest that short-termism might have negative effects on these companies themselves and their investors. There’s another surprise in the research: short-termism might not be as widespread as we think, and a substantial number of corporations are rising to the challenge. “One important takeaway is that firms with long-term horizons exist,” says George Serafeim, Asst. Professor at Harvard Business School, coauthor of the working paper ‘Short-termism, Investor Clientele, and Firm Risk’, with HBS doctoral candidate Maria Loumioti and Assistant Professor Francois Brochet. “Many companies are being managed for the long term,” says Serafeim.
The research team was interested in several issues: Do short-term companies attract a particular kind of investor? Is investing in these firms riskier than investing in companies with longer-term time horizons?
Their first order of business was to determine a method for categorising companies on the short-term/long-term continuum. The answer came in the very words used by executives to discuss their companies. Brochet, Serafeim, and Loumioti studied transcripts of 70,042 earnings calls where executives discuss quarterly results with investors, analysts, and the media that were held by 3,613 firms during 2002-2008. This involved searching for 14 terms used by management such as “latter half” and “weeks” that would tip off a short-term view, versus 15 words or phrases such as “long term” and “years” that would suggest a longer time horizon approach.
The researchers then compared their list of companies on both ends of the spectrum with the companies’ actual financial and stock performance, studying indicators such as return volatility, the length of time investors held a firm’s stock, and the cost of capital. The results showed that short-term companies attracted short-term investors (bringing with them a whole new set of performance pressures on executives) and that the financial and strategic performance of these companies was more volatile – and riskier – than that of the long-termers. The team also identified industries that appear to be short-term-oriented (banking, electronic equipment, business services, and wholesale) and long-term-focused (beverages, retail, pharma, and medical goods). Companies, too, were categorised by outlook. Short-termers included Cisco, Goldman Sachs, and Chevron, while the longer horizon outfits included Coca-Cola, Ford, and Nordstrom.
Question: In general, what relationship did you find between companies you identified as short-term-oriented, their investors, and the behaviour of their stocks?
Francois Brochet (FB): Overall, we found a positive association between the horizon over which firms communicate and the investment horizon of their shareholders. In addition, short-term-oriented firms appear to have more volatile stock returns and higher estimated cost of equity capital – that is, greater risk. While the presence of long-term-oriented investors appears to mitigate the positive association between firms’ short horizon and the volatility of their stock, this does not apply to the association between short-termism and cost of capital. We interpret this as evidence that our short-termism measure captures a dimension of non-diversifiable risk in the economy.
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