Managers walk a fine line. When they focus solely on the current value and price of their stock, it often leads to an over-emphasis on short-term profits at the expense of long-term profits. When they focus solely on long-term profits, it often leads them to ignore real-time investor concerns and the short-term impact on the stock price.
There are many times when managers must make decisions that appear to hurt the short-term profitability of the company but are necessary to keep the company on course—or change to a better course—for the company’s long-term sustainability. For example, consider a manager who decides to add a new business line knowing that it is complementary to the existing business lines. The new business line is expected to enable cross-selling between new products and existing products because both product lines target similar customer bases, boost sales of legacy products because of the complementary nature of the two lines of business, and enhance the company’s long-term growth prospects.
However, in the short-term, this initiative will compress earnings because the manager will need to add staff for the new business line and train them. Thus, total operating costs will increase before revenue comes online. If the manager can properly explain the objectives of the measures the company will undertake, preferably ahead of time if possible, it will help ease investors’ concerns and likely mitigate the negative impact of the short-term dip in earnings. Longer-term, it will help the company by adding a new revenue stream.
This is a good statement to keep in mind, because stockholder value can fluctuate wildly, and you don’t want to harm your overall production capability by focusing too much on it. Now, conceptually, it is far more complicated, because shareholder value and stock value can improve your operating income and give you liquid capital with which to work.
Overall, however, the job of managers is to keep their employees working and ensure long term profitability. Things exterior to the production ability and work force can drastically alter the stock price; examples include supply chain issues, international trade problems, buyout rumors, and much more. Because these factors can impact the stock price wildly, it is important to focus less on the stock price because you can’t control how it looks. Instead, managers should focus on their own production and what their employees are able to do.
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...
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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.
Further Reading
Discuss the statement “Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long term profits."
The issue of what is sometimes called "short-termism" or a focus on quarterly statements has become increasingly central to questions about the purpose of corporations and the ways that executives are compensated. Especially for firms that require technological innovation or are platform based, short term profitability can be an enemy of long term growth.
Platform companies such as Facebook, Amazon, Uber, and Twitter benefit from network effects. The more members they have, the more attractive they become to potential customers, leading to a virtuous growth cycle. As high prices or cost cutting measures can impede growth, many such companies can go for several years without showing a profit, but instead aim at increasing market share. Measures such as stock buy-backs, dividends, and increasing profitability by charging for services or increasing profit margins might harm such companies, while investing in R&D or logistics can help their long term growth, but may lower stock prices or earnings.
One major issue in executive compensation is that it is often tied to stock options, giving executives an incentive to increase stock value by mergers and acquisition or balance sheet manipulation rather than investing the money in R&D or quality improvement that will sustain their companies over the long term.