Ask the grumpies: Why are firms so short-sighted?

Leah asks:

Why do so many companies make decisions based primarily on short term economics and not long-term health of the company? Is it just the stock market, or is there more going on than that?

I am sure that people really do know the answer to this one in terms of how systems and laws and so on have changed to favor short-term over long-term… and I do know that a lot of that has to do with how bonuses and CEO compensation has radically increased over time, meaning short term gambles pay off a ton more than they used to.  So some of it is the stock market, but some of it is also how compensation and tax structures have changed.  This is really outside of my knowledge area though– my knowledge basically comes from skimming paper abstracts of general interest journals and working papers.

My short answer is that even though companies are supposed to be risk neutral, and are supposed to be trying for immortality, they are run by people.  And people are short-sighted.  If the rewards are for the short term and not for the long term, then that’s the direction they’ll go.

7 Responses to “Ask the grumpies: Why are firms so short-sighted?”

  1. monsterzero Says:

    >rewards are for the short term

    I always figured it was bonuses for quarterly or annual stock performance, or just compensation in the form of stock.

    Every few years I read another article wherein it’s pointed out that if corporations are people (per Mitt Romney), they are people who are immortal sociopaths. Also, some of these “people” are cannibals (e.g. Bain Capital).

    • becca Says:

      waiting for the vampire movie, where they reawaken after decades asleep, and give up on hunting humans because corporations are already sucking us dry

  2. Revanche @ A Gai Shan Life Says:

    I always also thought that people had adapted to a ‘me first’ type of mentality where they were just there to milk what they could out of the companies (so many bad CEOs, so many huge payouts anyway, so many mergers and acquisitions that gut companies, etc) and not there for the long term health of the company. And if so, that makes sense that they don’t make good long term decisions that might yield lower immediate rewards.

    • yetanotherpfblog Says:

      100% this. I don’t just think it’s CEO’s either. Middle management and individual bonus compensation is always a very “what have you done for me lately” sort of game as well. The short-term thinking is trickle down.

  3. nicoleandmaggie Says:

    I guess another important thing is that we don’t really live in a world of perfect competition, so bad behavior isn’t competed out.

  4. middle_class Says:

    Revache nailed it. Unless it is a family owned firm, the CEOs and top brass generally only care about pleasing stock holders and short term gains. There are exceptions but also many bad apples who ruin companies and get a big payout.

  5. Middle class Says:

    Here is a good article about how a shortsighted private equity firm ruined an established business.

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