The Puzzle of Short-termism

Abstract

From the Introduction: When pondering the question of the “sustainable corporation,” as we did in this symposium, one of the intractable problems is the nature of the corporation to produce externalities. By noting this characteristic, I am not making a moral point but an economic one. The nature of the firm is to create financial wealth by producing goods and services for profit; without regulatory or contractual limits, the firm has every incentive to externalize costs onto those whose interests are not included in the firm’s current financial calculus. In fact, because of the corporation’s tendency to create benefits for itself by pushing costs onto others, the corporation could aptly be called an “externality machine.”

The obvious kind of externality is the one that happens in the same time frame as the benefits gained. These current externalities take a number of forms. A company might refuse to provide health benefits to its employees, leaving Medicare or Medicaid to pick up the tab. The company might save on production costs by skirting environmental laws, thereby forcing communities, neighbors, or employees to suffer risks of harm that do not need to be accounted for on the company’s financial statements. Alternatively, the company could sell shoddy products to one-time purchasers, produce goods in sweatshops, or underfund employees’ pension funds.

These kinds of externalities are routine to notice and remark on. They are also the subject of some push-back from stakeholders and regulators. Those who bear the cost can assert their interests in various ways.

The more difficult kind of externality to address—especially if our focus is on the sustainability of the corporation—is the future externality. What I mean here is the kind of cost that a corporation’s management can externalize to the future. From management’s perspective, the future is a much more attractive place to push off costs. Stakeholders who must bear such future costs will be less aware of those costs than current costs, and even if they do learn of such future costs, they will be less able to gain the attention of regulators.

The aim of this Essay is to ask about one particular kind of future externality: future costs to shareholders. I recognize that shareholders are not usually the focus in a discussion of externalities. In the present, their interests are sufficiently (even if not perfectly) aligned with those of management that we need not concern ourselves with externalities borne by shareholders other than through the usual corporate governance tools. But in the case of future externalities, the analysis is more complex. Current shareholders may prioritize present returns over future returns, and current shareholders may not expect to be future shareholders at all. This means that corporate managers have incentives not only to externalize costs to current and future stakeholders whose interests they can ignore but also to future shareholders as well. This means that corporations will, by their very natures, be fixated on the short term.