On the Revival of the “Quarterly Capitalism” Discussion

Ok, I’m a little late with this, but, um, he might kind of have a point…

That said, he’s gonna be so mad when he finds out who took up the cause first. Let’s discuss…

Currently, publicly traded companies (“public companies,” though importantly distinct from being a government entity) are required to report their business performance once a quarter. This seems helpful from a transparency perspective, but it also has the unintended consequence of companies being obsessed with “hitting their numbers” every 90 days or so. This doesn’t *have* to be a problem, but it’s entirely likely that focusing on short-term profits comes at the expense of maximizing long-run profitability.

This phenomenon, sometimes referred to as “quarterly capitalism,” isn’t simply the result of companies trying to show off every time they have to release earnings numbers. Instead, they’re mainly responding to market incentives- stock prices tend to respond strongly to quarterly earnings, and the perceived performance of company managers is closely tied to stock performance. This basically creates the corporate equivalent of being judged on your weight-loss progress on a weekly basis, and, just like such reporting can lead to unsustainable binge dieting, quarterly financial reporting can lead companies to engage in analogous, say, inefficient cost-cutting measures.

Do I really think that moving to six-month reporting requirements would solve the quarterly capitalism problem? No, mainly since most useful long-term projects have timelines of far more than six months. (I also do worry about the decrease in transparency nowadays.) But I like that the conversation is being had, since it forces discussion of what is referred to by behavioral economists as “myopic loss aversion.”

“Myopia,” taken literally, means near sighted, and, in a decision-making context, means short sighted, or overly focused on the short run. Loss aversion is the phenomenon where people hate losses more than they like equivalent gains. Myopic loss aversion is thought to lead to irrational choices, or choices that are out of line with maximizing long-term returns (or, somewhat equivalently, happiness.). In a personal investing sense, one of the best pieces of advice I can give is to not look at your stock portfolio every day, since you’ll probably get obsessed with short-term ups and downs and start buying and selling in unproductive ways. In a similar sense, professional investors would often be well served to take the quarterly reports and put them in the desk drawer rather than poring over them…or at least focusing on the information that pertains to long-term plans rather than short-term results. (I’m of course making the assumption that the professional investors are working on behalf of clients who are taking a long-term view of their returns.)

Hopefully this makes sense as a logical matter, but unfortunately it’s harder to act on than it might seem. First, just knowing that they’re doing something unproductive doesn’t always make people able to stop doing the unproductive thing. (The dieting analogy keeps working here I suppose, albeit for different reasons!) In addition, it’s harder to stop being myopic when others involved in a market are still committed to the myopic behavior, and it’s extra hard to convince a whole bunch of people to change their thought processes at the same time. Nevertheless, well…glad we had this talk at least. Baby steps…

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