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Finance
How to shift managers’ focus from short-term profit to long-term social impact
Engaging long-term institutional investors and financial analysts can curb excesses of managerial short-termism and boost corporate social performance, argue Stephen Smulowitz, Didier Cossin, and Abraham Hongze Lu.
A persistent challenge facing leaders across industries, countries, and cultures is the relentless focus on short-term results. This pressure for immediate performance can trap organizations in a cycle where long-term planning and sustainable growth take a backseat.
Daily demands and constant performance metrics often keep leaders locked into a narrow, short-term perspective. Few executives cultivate the broader vision necessary to drive their companies toward success over the next five or ten years, leaving long-term goals overshadowed by the urgency of immediate returns.
While the negative impact of this short-term focus on financial performance is widely recognized, its effect on corporate social performance (CSP), which encompasses a company’s environmental, social, and governance (ESG) initiatives remains less understood.
One of the biggest challenges in tackling this issue has been measuring managerial short-termism, which stems from biases that are often hard to detect. Analyzing earnings manipulation, high employee turnover, and a lack of long-term vision in communication provides only a partial view. Our study overcame these shortcomings by analyzing the language used in the annual 10-K reports of 1,665 US companies from 2000-2012. It allowed us to gain insights into managers’ mindsets. We were able to detect the main drivers that influenced corporate decision-making.
Our analysis revealed that firms led by managers with a short-term focus tended to invest less in social and environmental initiatives. Instead, they often used corporate social performance (CSP) as a tool for impression management, while cutting back on areas that did not directly contribute to immediate profits.
Why do managers still make decisions based on financial short-termism when they know that CSP is no longer a ‘nice to have’?
Agency theory highlights how managers, driven by personal incentives, often sacrifice long-term success for immediate financial gain. Managerial short-termism often arises from a divergence between the interests of corporate stakeholders and managers. Long-term investors typically prioritize sustained growth and future value creation, while managers prioritize a company’s immediate financial performance. They focus on quarterly results motivated by personal incentives like bonuses and job security.
What are the levers for combating stubborn managerial short-termism?
Our research showed how boards can engage external monitors to counterbalance short-term pressures, preserving important CSP investments. Boards can combat the excesses of managerial short-termism through external monitoring by institutional owners and investment analysts who value CSP. We explore how to attract these stakeholders.
“Executives often argue that pressure from investors focused on short-term results forces them to make decisions that compromise their commitments to long-term goals.”
Attract institutional owners who value CSP
Our study found that increased institutional ownership improved CSP and limited the excesses of managerial short-termism.
Executives often argue that pressure from investors focused on short-term results forces them to make decisions that compromise their commitments to long-term goals. However, our research reveals the reverse is also true: executives with a short-term mindset tend to attract investors who are equally fixated on quarterly performance. But not all institutional investors are alike. While transient investors tend to focus on short-term profits, dedicated institutional investors, those with substantial long-term holdings, play a crucial role in ensuring that managers balance immediate returns with sustainable, long-term value.
Not all institutional investors are alike. Long-term institutional investors, such as BlackRock, have considerable influence over corporate behavior. In his 2021 letter to CEOs, CEO of BlackRock Larry Fink said, “The more your company can show its purpose in delivering value to its customers, its employees, and its communities, the better able you will be to compete and deliver long-term, durable profits for shareholders.” Institutional investors, such as BlackRock, have the power to influence managerial behavior through two key mechanisms:
- The threat of exiting their investments, which could trigger a significant drop in stock price.
- By using their voice to advocate for corporate policy changes through proxy campaigns, shareholder resolutions, and media influence.
Our study supports the idea that institutional investors play a vital role in safeguarding CSP investments, ensuring that sustainability efforts are not sacrificed to meet short-term earnings expectations.
Dedicated institutional investors bring several advantages that make them effective guardians against the negative effects of short-termism. Firstly, their concentrated ownership gives them the incentive to closely monitor management and ensure that decisions align with long-term growth. Secondly, their deeper knowledge of a firm’s operations and strategy enables them to offer more informed assessments of managerial performance, particularly when it comes to complex CSP investments. Lastly, their longer-term perspective helps shield managers from the pressure to underinvest in sustainability initiatives, as these investors understand the long-term value that CSP can bring in terms of growth opportunities and risk reduction.
Wield the double-edged sword of analyst pressure
Analyst pressure can be a double-edged sword. Firms that miss earnings forecasts face market penalties, prompting managers to either underestimate earnings expectations or cut long-term initiatives to align with profit forecasts. This “quarterly earnings race” incentivizes executives to prioritize short-term results, often at the expense of CSP, leading to reputational damage or even job loss. Consequently, the influence of financial analysts on CSP is often met with skepticism, as their pressure can undermine long-term sustainability in favor of immediate financial gains.
Analysts serve as external governance mechanisms, reducing the information gap between managers and shareholders
Increasing analyst coverage can help reduce the negative impact of short-term managerial thinking on CSP
From an agency theory perspective, increasing analyst coverage can help reduce the negative impact of short-term managerial thinking on corporate social performance (CSP). Analysts serve as external governance mechanisms, reducing the information gap between managers and shareholders. They evaluate managers’ performance and strategic decisions through ratings, forecasts, and public scrutiny, playing a crucial role in holding executives accountable. By questioning firm strategies and providing detailed insights through reports, analysts limit managerial opportunism and help align decisions with long-term corporate goals.
We argue that analysts are increasingly recognizing the value of CSP in driving long-term success. Studies revealed that analysts now factor CSP into their evaluations and often reward firms with high CSP ratings as they become more aware that CSP investments can enhance a firm’s competitive advantage, boost social legitimacy, and improve overall financial performance. As analyst coverage increases, it could encourage managers to maintain or even increase their commitment to CSP, signaling to the market that the firm is focused on sustainable, long-term growth.
External monitoring arising from the involvement of long-term institutional investors and the evolving role of analysts can help shift managerial focus away from unsustainable short-term results to long-term value creation that enhances CSP.
Implications for boards
By shedding light on the relationship between managerial short-termism and CSP, our study highlights the need for stronger governance mechanisms that encourage managers to prioritize long-term value creation. By identifying how short-term thinking affects CSP, our research was able to understand the mindset behind managerial short-termism and identify ways to counteract it. Our study found that more institutional ownership and analyst coverage, by players which value CSP, mitigates the worst excesses of managerial short-termism. External monitoring arising from the involvement of long-term institutional investors and the evolving role of analysts can help shift managerial focus away from unsustainable short-term results to long-term value creation that enhances CSP.
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