A Partial Defense of Our Obsession with Short-Term Earnings

Here’s a conundrum: On the one hand, there’s a consensus among thoughtful business leaders that too many companies are sacrificing long-term growth on the altar of smooth, reliable short-term earnings. On the other hand, most large sample studies in the accounting literature show something different: firms that manage their earnings perform better than firms that don’t (and not just in the short term).

“The capital markets are a huge problem.” I got curious about that partly because I’m involved in a reimagining-capitalism project. My colleague Clayton Rose and I set out to discover whether the capital markets really are a problem, and we just couldn’t find much — or any — any evidence that this was true. You can’t find it in the accounting literature. One way to think about it is at the country level. Germany and Japan are both much more long-term focused than the U.S., the capital markets are much stickier. Do the firms do better? No. They don’t do worse, but they don’t do better.

One big issue is whether you communicate successfully to the markets. If you’re Amazon, Disney, some of the pharmaceuticals…the markets support their huge long-term investments because they can see where the investments will lead. If they don’t understand your long-term plans, or they don’t trust you to deliver on them – the markets are going to say, I don’t think so.

And in the case of a company on the edge, that might be all right. Sometimes the capital markets are right not to trust a company’s promises about the future.

But maybe the simple takeaway is this: so long as you’re in good shape, earnings management is harmless. But if you’re really close to the edge, managing earnings can be disastrous because you cut too deeply and get into a vicious, downward spiral.

https://hbr.org/2015/05/a-partial-defense-of-our-obsession-with-short-term-earnings