This content is from: Portfolio

New Evidence Shows That Investors See Through Short-Termism

Companies that try to boost their stock prices by inflating current earnings can expect punishment from the market, a recent long-term study reveals.

The jury has long been out on whether the market punishes companies for so-called managerial myopia — attempts to boost stock prices by inflating current earnings. Empirical studies are scant. Feida (Frank) Zhang, an accounting lecturer at Murdoch University in Perth, Australia, addressed that shortcoming in a recent paper he co-authored with University of Western Australia assistant accounting and finance professor Yixing (Jamie) Tong.

Taking some 2,700 U.S. public corporations from 1972 to 2008, the pair divided them into two groups: those reporting negative earnings that would have been positive if they’d cut R&D spending and those reporting positive earnings to meet targets they wouldn’t have hit without such cuts. Investors consistently penalized the second group with lower returns in a five-day period around the earnings announcement. “They understand that these companies get positive earnings simply because they cut R&D and that this sort of behavior will hurt the companies’ long-term performance,” Zhang explains.

Noting that managerial myopia is tough to measure, Zhang says he and Tong used an accounting methodology that he suspects would be unfamiliar to economics and finance scholars. Better understanding of the phenomenon may not be enough to banish it, he wagers: “In the future, such behavior may be less popular, but I think maybe it will still exist for a long time.” • •

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