Making the Numbers? 'Short Termism' and the Puzzle of Only Occasional Disaster

Hazhir  Rahmandad; Rebecca   Henderson; Nelson P. Repenning

Article | Management Science | March 2018

Making the Numbers? 'Short Termism' and the Puzzle of Only Occasional Disaster

by Hazhir Rahmandad, Rebecca Henderson and Nelson P. Repenning

Abstract

Much recent work in strategy and popular discussion suggests that an excessive focus on "managing the numbers"—delivering quarterly earnings at the expense of longer-term investments—makes it difficult for firms to make the investments necessary to build competitive advantage. "Short termism" has been blamed for everything from the decline of the U.S. automobile industry to the low penetration of techniques such as TQM and continuous improvement. Yet a vigorous tradition in the accounting literature establishes that firms routinely sacrifice long-term investment to manage earnings and are rewarded for doing so. This paper presents a model that reconciles these apparently contradictory perspectives. We show that if the source of long-term advantage is modeled as a stock of capability that accumulates over time, a firm's proclivity to manage short-term earnings at the expense of long-term investment can have very different consequences depending on whether the firm's capability is close to a critical "tipping threshold." When the firm operates above this threshold, managing earnings smoothes revenue and cash flow with few long-term consequences. Below it, managing earnings can tip the firm into a vicious cycle of accelerating decline. Our results have important implications for understanding managerial incentives and the internal processes that create sustained advantage.

Keywords: capability; Short-termism; system dynamics; tipping point; resource allocation; Business or Company Management; Earnings Management; Resource Allocation;

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Rahmandad, Hazhir, Rebecca Henderson, and Nelson P. Repenning. "Making the Numbers? 'Short Termism' and the Puzzle of Only Occasional Disaster." Management Science 64, no. 3 (March 2018): 1328–1347.

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In the fall of 2018, Hiro Mizuno, the Chief Investment Officer (CIO) of GPIF, the Japanese Government Pension Fund, was reflecting on his efforts to integrate Environmental, Social and Governance (ESG) issues into every aspect of GPIF’s portfolio. His efforts ranged from constructing new stock market indices based on ESG data, changing the compensation and incentives of active investment managers and passive funds, pushing for more corporate sustainability reporting and integrated reporting, and establishing collaborations with other asset owners to drive systems level change. He was convinced that the only way to meet his responsibilities to his beneficiaries was to improve the performance of the entire economy through a focus on improving corporate governance, increasing inclusion in the workplace and gender diversity and reducing environmental damage and progress towards tackling climate change. The early results from his efforts were promising, but was there more he could do?

Technical Note | HBS Case Collection | December 2018

Note on Economic Inequality (2018)

Rebecca Henderson, Clayton S. Rose, Jessica A. Gover and Aldo Sesia

For over half a century, most of the world's economies have enjoyed steady growth and prosperity. While this economic growth has reduced the number of people living in poverty, it has come with an increase in economic inequality. The gap between the "haves" and the "have-nots" in developed countries has widened, with a small proportion of the population reaping an increasingly larger share of a country's economic rewards. This growing economic inequality has been particularly pronounced in the United States, but the phenomenon has also occurred in many nations. This note provides background on aspects of economic inequality. It begins by describing both income inequality and wealth inequality, providing an explanation of two widely used metrics and data that show increasing inequalities over time. It then moves to the factors that might contribute to this inequality, as well to propositions of economic and social consequences that might result from the widening gap. Finally, it addresses the issue of "equality of opportunity" or social mobility. This is an update to the Note on Economic Inequality (2015). It provides additional information on economic inequality, including union membership and inequality and political polarization.

Keywords: Economic inequalty; wealth inequality; equality of opportunity; political polarization; Economic Growth; Economics; Income; Wealth; Equality and Inequality; Society; Problems and Challenges;

Citation:

Henderson, Rebecca, Clayton S. Rose, Jessica A. Gover, and Aldo Sesia. "Note on Economic Inequality (2018)." Harvard Business School Technical Note 319-071, December 2018. View Details

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Mark Bertolini, chairman and CEO of the health insurer Aetna, faces a number of questions as he seeks to transform Aetna from a classic insurance company into a business that will engage much more deeply with its members around their personal health goals. His strategy depends on Aetna’s ability to facilitate behavioral changes amongst its members to live healthier lives and requires very significant investments in digital capabilities and on-the-ground community-orientated health care resources. Will it work? Can he implement it? The case explores both the strategic issues inherent in this potential transformation and the organizational and leadership questions that it raises. Bertolini is a highly purpose-driven leader, and the case allows for a rich discussion of the degree to which this changes both his strategic and his organizational options.

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Making the Numbers? 'Short Termism' and the Puzzle of Only Occasional Disaster

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