When 'making the numbers' makes sense

"Short-termism" – an ugly phrase for an ugly approach to management – is widely blamed for everything from asset bubbles to outsourcing. There's a argument, of course, that the long term is just the sum of all short terms, but when it comes to deciding on a specific project or investment, the outcome often differs radically based on which stance you take. The issue becomes more complex when investors (or at least certain types of investor) agitate for performance over a narrow time horizon. Corporations face constant demands for guidance on "the numbers" – the quarterly or half-yearly earnings report – and then get punished by markets (or really by certain types of market trader) when they fail to meet them. "Making the numbers" is a mug's game.

Or is it? According to a study by scholars at MIT and Harvard, there are conditions – a "tipping threshold" – above which is makes sense to make the numbers by focusing on the short-term at the supposed expense of longer term consideration. "We show that if the source of long-term advantage is modeled as a stock of capability that accumulates gradually over time, a firm's proclivity to manage short-term earnings at the expense of long-term investment can have very different consequences," they write. When the company operates above the threshold, earnings management can smooth revenue with few long-term consequences. "Below it, managing earnings can tip the firm into a vicious cycle of accelerating decline. Our results have important implications for understanding managerial incentives and the internal processes that lead to sustained advantage," they conclude.

Source document: The working paper "Making the Numbers? 'Short Termism' & the Puzzle of Only Occasional Disaster," by Nelson Repenning of MIT and Rebecca Henderson at Harvard, is a 39-page pdf file.