Please evaluate the following statement: Managers should not focus on current stock value because it leads to an over-emphasis on short-term profits at the expense of long-term profits.
In order to determine whether a business manager is over-emphasizing short-term value at the expense of the long-term interests of the company and its shareholders, one has to consider the position of that particular manager. Optimally, a balance can be found between short and long-term objectives. This is not always possible, however, and the personal interests of management and a certain percentage of stockholders have to be considered. There is usually pressure on management to perform at a certain level and failure to do so can result in demotion or termination. Unfortunately, that decision is sometimes based upon short-term considerations. Dividends are calculated and distributed among shareholders on a quarterly basis and pressure from a small but influential group of shareholders for immediate gratification can result in a failure by management to make decisions that adequately reflect concern about the enterprise's long-term well-being.
Much that keeps businesses competitive over a long period of time involves decisions that reduce dividends. A manufacturer, for example, has to look out over a period of years and determine the optimal time to invest in plant recapitalization while also, perhaps, ensuring the stability of an employee pension fund. These are serious financial costs that require management to, in effect, maintain a corporate savings account. That savings account is supplied through company profits—profits that would otherwise be distributed to shareholders. In addition, investments have to be made in future product development and this money also comes from profits withheld from shareholders.
A management team or manager who wants to ensure the long-term welfare of the business in question has to perform calculations that both maximize short-term profits and provide for the well-being of the company and of those shareholders who invested their hard-earned money for long-term gain. Some investors are in for the early returns and others for the long-term. Neither can or should be neglected.
Fittingly dubbed "short-termism," this idea refers to the tendency of managers to focus on short-term objectives at the expense of long-term growth. The costs and benefits of this approach are widely debated, with some opinions stating that short-termism does not even exist. However, it is generally accepted that some business leaders have been shown to have adopted this approach, especially when doing so leads to higher salaries and an illusion of success, thereby conferring greater job security to these individuals. Additionally, short-termism has been linked to the rise of corporate buybacks, a practice in which a company repurchases their own stocks instead of focusing their resources on the company's projected growth. To a certain extent, this practice is necessary when businesses find themselves lacking in opportunity for subsequent investment. Very often, however, buybacks are used as a means to even out earnings and increase share prices, and if this is the case, buybacks are an example of a short-termist approach that would ultimately harm a business in the long term. So yes, it is true that in some cases, emphasizing short-term profits can lead to long-term damage in some cases, but the overall effects of this approach are more ambiguous than this question suggests.
It is true that it is possible to increase the short term profit of a company at the cost of long-term performance and profit if the company. Further, because of the nature of stock markets, the short-term variations in performance can cause disproportionately high variations in market prices of the stock of the company.
Because of these two reasons it is far more easier for managers to increase stock prices of the company in short-term, than improve the real worth of company's stocks, and with that consistently high stock value, in the long-term.
Many managers are tempted to adopt this easier approach, because either they are not able to visualize the long-term impact of their short-term thinking, or deliberately to achieve their personal objectives of personal advancement by appearing capable managers in eyes of others. A practice like this may or may not benefit the manager, but most certainly it is not in the interest of the company, or its long-term shareholders.
There are several ways in which company a company can show higher profit in short-term at the cost of long-term performance. Some of these are described below.
- Cutting down expenditure for R & D in areas like product development and process improvement.
- Cutting down on new investments designed to increase productive capacity and improve production efficiency.
- Cutting down expenditure in activities such as Business Process Engineering and Industrial Engineering, designed to improve organizational efficiency and effectiveness.
- Cutting down manpower to the minimum required so that, managers are too busy with day to day activities, and too concerned with immediate performance to take care of long term interests of the company. This also hampers the ability of the company to absorb the shocks of fluctuating workloads and employee turnover.
- Cutting down on employee development and training activities.
- Cutting down on advertisement and other activities for developing brand value, and improving market share.
- Cutting down on plant and equipment maintenance activities. This reduces the maintenance cost in the short-run, but leads to equipment damage and higher maintenance cost in the long-run.
- Forcing supplies to reduce prices of the raw material and components supplied by them. Suppliers , frequently accept such forced price cuts as they have no immediate alternative, but in the long-term it reduces their level of commitment and support towards such customers.
- Reducing margins and and other costs of distribution channel partners. Effect of this is similar to that of reducing supplier price.
- Increasing price of products under condition of short-term market shortage.
- Reducing production cost by reducing the quality of the product supplied. Frequently, customers take some time to take note of the poor quality and change the suppliers or brands.