05 Jul 2016 21:33 IST

Short-termism is a problem, both in crime and corporate affairs

The obsessive focus on short-term goals works to the detriment of delivering long-term value to shareholders

It is, of course, for the Courts to deliver a verdict on the culpability or otherwise of Ramkumar, the accused in the murder last month, in Chennai, of a woman software professional. But from his judicial confession, as reported in the newspapers, this much can be said with certainty. If he was provoked into committing such a heinous act, and there is no proof yet for the alleged provocation, his response had been venomous, brutally excessive and far out of all proportion to the alleged mistake on the part of the victim.

Even had there indeed been disparaging references to his dark looks, as he is reported to have claimed in his judicial confession, and also granting his twisted logic that it seemed to warrant a punishment to be inflicted by him rather than by a state authority, did it really warrant extinguishing permanently the life of another person? Would nothing else have assuaged that sense of hurt that he seemed to experience?

That would, of course, be the typical societal response from a moral standpoint. But students of management ought also to reflect on the implications of the thought process behind murder accused Ramkumar’s fateful decision. Did he consider the possibility that he might be caught and punished for the crime? Was he absolutely certain that none of the persons gathered at the railway station at that critical moment would intervene as they would be frozen into inaction out of a collective sense of fear and paralysis?

Or, having considered it, was he confident enough in the belief that he might get away with it — the intrusive nature of surveillance in public spaces that modern technology has made possible, notwithstanding? Of course, not. For, if he had, it would have been abundantly clear to him that even assigning a miniscule probability for such an outcome would result in a negative payoff of an order that far outweighed the positive gains (temporary satisfaction implicit in the assuaging of the feelings of hurt) that his act of murder had supposedly achieved.

Not thought out

Consider the possibilities. He stands the risk of being convicted of ‘first-degree’ murder with possible the life imprisonment, if not execution. Even the most optimistic scenario of being eventually acquitted (a big ‘if’) would be small comfort as he would still face the prospect of imprisonment for an extended period while the trial is on. The prosecution is bound to object to any terms of release on bail as he would be considered a serious ‘flight’ risk.

Clearly, he had not thought beyond the immediate goal of retribution for someone spurning his protestations of love and the feeling of injury that such a rejection triggered. No matter how grave the injury is to the heart or whatever be the other mitigating circumstances, the consequences of his action are bound to be far worse and more enduring then the transient joy of avenging an insult.

In financial management jargon, the expected value of future costs (negative income) of a course of strategic action is a lot higher than the current income (sense of satisfaction in extracting retribution). Ramkumar had been guided solely by the short-term benefits of a course of action without giving a moment’s consideration for the long-term implications of what he had set out to do. In short, he had been guilty of what, in strategic management literature, would be labelled as behaviour conditioned by ‘short-termism’.

Near-term obsession

The expression ‘short-termism’ in the context of managing business enterprises can be described as an obsessive focus on the short-term goals to the detriment of delivering sustainable long-term value to the shareholders.

A classic example would be the concern of a CEO, to the exclusion of everything else, about the quantum of per share earnings of his company in the forthcoming quarter. He would be undertaking only such activities as would reflect favourably on the earnings per share of the company while spurning other courses of action as they would either do little to improve the quarterly earnings and, worse, might even negatively impact it.

To illustrate, imagine that the company is sitting on a cash pile and the CEO has a choice of ploughing that into a new venture or using it to buy the company’s own shares in the secondary market. A CEO with a short-term focus would inevitably choose the latter. Why? Under the former course of action, the cash invested in a new venture would take quite a while before it starts generating profits and it would be many, many years thereafter for the full sum invested in the new venture to be fully recovered.

In contrast, the money ploughed back into buying the company’s shares in the market would go to reduce the number of outstanding shares while doing nothing to endanger the quantum of the current quarter’s profits. Consequently, the EPS would look better under a share buy-back option rather than if the money had been invested in a new and promising venture. But here’s the catch. The existing venture might, sooner or later, come up against a phenomenon of diminishing returns as more competitors enter the scene or customer preferences undergo a change, resulting in product obsolescence.

Lost opportunity

In the event, a decision to divert the cash into a new venture might pay dividends for the company as it now owns a new stream of cash-flows to compensate for the decline in an existing line of business. Such an opportunity would have been lost because the CEO chose to focus on the immediate future or the short-term benefits, forsaking, thereby, the prospect of sustaining the current level of cash-flows in the future.

Why do CEOs have such a short-term horizon for their strategic decisions? One explanation is that modern corporations are owned substantially by institutional investors such as mutual funds, pension fund and so on. They are themselves under immense pressure to show results from their constituent-investors. As exits from a fund are relatively easy for investors, there is a danger of fund managers facing redemption pressures because their own fund has performed relatively poorly in comparison to some other fund.

They, in turn, exert pressure on CEOs to consistently show growth in EPS from one quarter to the next, and the stock market rewards the company’s stock by marking it up even further. Moreover, a poorly performing company (measured on quarterly profit growth) faces the prospect of becoming a target for acquisition by a more aggressive firm with a better record of quarterly profit growth. And if the acquisition is successful, the incumbent CEO is out of a job as well. It is not hard to see why a CEO is obsessively concerned with quarterly EPS.

Preferring share buy-backs to costly fresh investments is not the only way by which CEOs exhibit their preference for the short-term goal of raising quarterly profits to the exclusion of anything that suggests of a long view of a company’ profitability and adding to shareholder value. A marked disinclination for committing expenditure for research and development activities which may or may not lead to new products being developed for the market, is another problem area for long-term sustainability of value for a business.

CEO’s near-term view

A Harvard Business Review article published last year quoted legendary management guru Peter Drucker as writing an opinion piece in the Wall Street Journal to that effect. It had Drucker saying, “Everyone who has worked with American management can testify that the need to satisfy the pension fund manager’s quest for higher earnings next quarter, together with the panicky fear of the raider, constantly pushes top managements toward decisions they know to be costly, if not suicidal, mistakes”.

If shareholders are really concerned about the long term implications of a CEO’s narrow, short-term focus, they can counter it in one or two ways. Make the tenure of the CEO sufficiently long so that he does not constantly have to look back at quarterly profits to secure his hold on the job. In the event, his performance can also be subjected other countervailing metrics, such as the ratio of R&D expenditure to total revenue, or the ratio of incremental growth in the fixed asset base to total assets.

That said, empirical data or other research evidence is equivocal in its findings. While CEOs may be guilty of ‘short-termism’, it is far from certain that firms end up paying punitive costs over the long term.

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