A Question about Corporations and Financial Markets

by Don Boudreaux on February 14, 2011

in Financial Markets, Prices

In today’s New York Times, Felix Salmon writes:

A private company’s stock isn’t affected by the unpredictable waves of the stock market as a whole. Its chief executive can concentrate on running the company rather than answering endless questions from investors, analysts and the press.

There’s much less pressure to meet quarterly earnings targets. When the stock does trade, the deals can be negotiated quietly, in private markets, rather than fall victim to short-term speculation from the high-frequency traders who populate public markets.

Question to readers more familiar than I am with the literature on finance, financial markets, and corporations: Has there been rigorous empirical research on the extent to which corporate executives focus on quarterly earnings to the detriment of their firms’ long-run profitability?

Popular belief seems to have it that such obsession with the short-run is the order of the day for publicly traded corporations (at least in the U.S.).  Whether or not – and to the extent that – this popular belief is true is an empirical matter.

On one hand, the more well-functioning are markets, the more likely will this afternoon’s share prices reflect the long-run, future consequences of this morning’s executive decisions.

On the other hand, to the extent that market aren’t perfect (which is surely ‘at least somewhat’) companies whose executives focus on their companies’ long-run profitability irrespective of what that focus does to short-run earnings and share prices will fare better over the long-run than will companies whose executives focus inordinately on short-run performance measures.  Does the evidence tell us that, even when there is reason for executives to believe that short-run share prices don’t adequately reflect the future prospects of their companies, executives (1) generally or (2) sometime or (3) seldom to never keep focused on the future?

Anyone know what the evidence says?

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