Note the extraordinariness of this statement, whose truth I don’t much doubt.
I have strong doubts about its generality.
I am sure there are industries where management is reluctant to make long-term investments. I will hazard a guess that in these industries there is a lot of uncertainty about the future—future products, future demand, future technology, etc.
However I am also sure that there are industries where long-term investment is how these industries work. Computer chip fabs come to mind, or, say, the aerospace factories.
It matches up with my experience, with the caveat that it is much more true for publicly held firms than privately held firms. I remember a project I was working on for a warehouse management software company; the advising professor commented something along the lines of “well, if they can show they make the money back in five years, then it’s a win to invest,” and we responded with “actually, the decision horizon for most of their clients is about a year or two.” He was visibly shocked by the implied difference in time horizons.
The argument for this mostly comes in the implicit discounting of promises. If the salesman claims it has an effect size that large, then very possibly it will actually pay off once you account for the total cost of installation and ownership. The cynical observation is it has something more to do with the quarterly cycle of businesses- investments need to pay back for themselves rather quickly, or it may be your successor who reaps the benefits of your investments. Privately held firms have noticeably longer time horizons, make more of these long-term investments, and that appears to be a major cause for them often performing better in the long run than publicly held businesses.
Privately held firms have noticeably longer time horizons, make more of these long-term investments, and that appears to be a major cause for them often performing better in the long run than publicly held businesses.
This sounds way too much like a cached thought to me. I’d like to see empirical data for that.
In general, however, we’re talking about optimal planning horizons for businesses. As soon as you formulate the problem this way it becomes obvious that the answer is “it depends”. I don’t think a useful generic answer is possible—businesses, from an iPhone-case producer to, say, Intel, are too diverse for that.
A related question (much studied, I think) is the impact of the agency problem on business management. It surely exists but I don’t know whether it translates so straightforwardly into preferences for the short term and unjustified discounting of the long term.
This sounds way too much like a cached thought to me. I’d like to see empirical data for that.
Note that privately held companies includes both companies held by a family (which tend to be less well managed because of the frictional costs associated with replacing upper management) and companies held by private equity firms (which tend to be well-managed). The NBER paper gwern linked through Hanson is available here, and if that link doesn’t work for you I can email you a pdf.
A quote from it:
Table 1 also shows that private firms have higher profits, less cash, and more debt, even after we match on size and industry.
Thanks for the link, it works. The paper’s interesting but will take a bit of time to dig through and I can already see some iffy things in there (e.g. using sales growth as the measure of investment opportunities available). But I’ll hold off expressing opinions until I read through it...
We also find substantial variation in management practices across organizations in every country and every sector, mirroring the heterogeneity in the spread of performance in these sectors. One factor linked to this variation is ownership. Government, family, and founder owned firms are usually poorly managed, while multinational, dispersed shareholder and private-equity owned firms are typically well managed.
I don’t think this supports the claim made.
The second link points to a NBER article behind a paywall (for me). Looking at the abstract, however, it doesn’t say anything about preferences for long-term vs short-term. The most relevant data point that I see is that private firms invest more (as % of assets) than public firms, but I’d want to see the details of the study before coming to a conclusion about what that means.
It sounds like memetic junk which on the surface looks plausible and has been circulating via the popular media for a long time though its empirical foundations are doubtful and it’s usually formulated in too generic a fashion to be of any use.
As I might have mentioned before, my prior with respect to popular economic wisdom is that it’s false.
This is understandable, and is a fairly common dynamic. It’s a 2 level principle/agent problem.
The goal of investors is to maximize their long term investment. They do this by using the limited tools available, such as paying management bonuses based on profitability, so managers don’t simply exploit their position to be lazy, or worse, make small amounts of money at the expense of the company.
The personal goal of management isn’t to maximize long term value, it is to maximize short term profits, as measured by stock prices. Long term investments are costly, and because it’s impossible over the 2 year time frame to tell the difference between prudent long term investment and simply increased expenses, stock prices drop when expenses go up for any reason.
Note the extraordinariness of this statement, whose truth I don’t much doubt.
I have strong doubts about its generality.
I am sure there are industries where management is reluctant to make long-term investments. I will hazard a guess that in these industries there is a lot of uncertainty about the future—future products, future demand, future technology, etc.
However I am also sure that there are industries where long-term investment is how these industries work. Computer chip fabs come to mind, or, say, the aerospace factories.
Beware the fallacy of the Chesterton’s Fence.
It matches up with my experience, with the caveat that it is much more true for publicly held firms than privately held firms. I remember a project I was working on for a warehouse management software company; the advising professor commented something along the lines of “well, if they can show they make the money back in five years, then it’s a win to invest,” and we responded with “actually, the decision horizon for most of their clients is about a year or two.” He was visibly shocked by the implied difference in time horizons.
The argument for this mostly comes in the implicit discounting of promises. If the salesman claims it has an effect size that large, then very possibly it will actually pay off once you account for the total cost of installation and ownership. The cynical observation is it has something more to do with the quarterly cycle of businesses- investments need to pay back for themselves rather quickly, or it may be your successor who reaps the benefits of your investments. Privately held firms have noticeably longer time horizons, make more of these long-term investments, and that appears to be a major cause for them often performing better in the long run than publicly held businesses.
This sounds way too much like a cached thought to me. I’d like to see empirical data for that.
In general, however, we’re talking about optimal planning horizons for businesses. As soon as you formulate the problem this way it becomes obvious that the answer is “it depends”. I don’t think a useful generic answer is possible—businesses, from an iPhone-case producer to, say, Intel, are too diverse for that.
A related question (much studied, I think) is the impact of the agency problem on business management. It surely exists but I don’t know whether it translates so straightforwardly into preferences for the short term and unjustified discounting of the long term.
Note that privately held companies includes both companies held by a family (which tend to be less well managed because of the frictional costs associated with replacing upper management) and companies held by private equity firms (which tend to be well-managed). The NBER paper gwern linked through Hanson is available here, and if that link doesn’t work for you I can email you a pdf.
A quote from it:
Thanks for the link, it works. The paper’s interesting but will take a bit of time to dig through and I can already see some iffy things in there (e.g. using sales growth as the measure of investment opportunities available). But I’ll hold off expressing opinions until I read through it...
Here’s two links: http://www.overcomingbias.com/2012/02/econ-advice-confirmed.html and http://www.overcomingbias.com/2012/02/info-market-failure.html
So let’s take a look at these links.
From the first one:
I don’t think this supports the claim made.
The second link points to a NBER article behind a paywall (for me). Looking at the abstract, however, it doesn’t say anything about preferences for long-term vs short-term. The most relevant data point that I see is that private firms invest more (as % of assets) than public firms, but I’d want to see the details of the study before coming to a conclusion about what that means.
It certainly is consistent with the claim made, even if it is not as on-point as the second link I had been searching for, and so I included it.
A thought being cached is not evidence against it.
OK, I’ll be more explicit :-)
It sounds like memetic junk which on the surface looks plausible and has been circulating via the popular media for a long time though its empirical foundations are doubtful and it’s usually formulated in too generic a fashion to be of any use.
As I might have mentioned before, my prior with respect to popular economic wisdom is that it’s false.
Do you mean because it seems short-sighted? I suspect there is a business reason for having such a heuristic, but I might be wrong.
This is understandable, and is a fairly common dynamic. It’s a 2 level principle/agent problem.
The goal of investors is to maximize their long term investment. They do this by using the limited tools available, such as paying management bonuses based on profitability, so managers don’t simply exploit their position to be lazy, or worse, make small amounts of money at the expense of the company.
The personal goal of management isn’t to maximize long term value, it is to maximize short term profits, as measured by stock prices. Long term investments are costly, and because it’s impossible over the 2 year time frame to tell the difference between prudent long term investment and simply increased expenses, stock prices drop when expenses go up for any reason.