Operational Distortion: Compound Effects of Short-termism and Competition

Forthcoming at Management Science

56 Pages Posted: 7 Sep 2021

See all articles by Xiaoyan Liu

Xiaoyan Liu

Santa Clara University, Leavey School of Business; Cornell University - Samuel Curtis Johnson Graduate School of Management

William Schmidt

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: September 4, 2021

Abstract

Practitioners and academics alike have argued that a firm's interest in its short-term capital market valuation (short-termism) is harmful to the firm's long-term profit. Their argument is intuitive -- when a firm exhibits short-termism, its decision making will cater to the short-term at the expense of the long-term. Some practitioners claim that the adverse effects of increased short-termism become particularly acute in competitive markets. However, there is little academic research that examines the compound effect of short-termism and competition on a firm's operational choices and long-term profit. In this paper, we provide a rigorous analytical model to examine how short-termism and competition can interact to induce a firm to distort its capacity investment and affect its long-term profit. We model a firm that has private information about its market demand, which can be either high or low and is captured by the firm's type. Signaling this private information can influence both the investor's valuation and the competitor's entry decision. We find that operational distortion can emerge not only when short-termism is large, but also when it is small. In fact, when short-termism is sufficiently small, both firm types will distort their operational decision by under-investing in a pooling outcome. We show, however, that the impact of short-termism on a firm's long-term profit is not monotonically negative, and a certain level of short-termism can be beneficial to a firm's long-term profit. The positive impact of incremental short-termism is robust to alternative modeling assumptions, including the form of competition and the investor's risk profile.

Keywords: operational distortion, short-termism, competition, information asymmetry, signaling game

Suggested Citation

Liu, Xiaoyan and Liu, Xiaoyan and Schmidt, William, Operational Distortion: Compound Effects of Short-termism and Competition (September 4, 2021). Forthcoming at Management Science, Available at SSRN: https://ssrn.com/abstract=3917597

Xiaoyan Liu (Contact Author)

Santa Clara University, Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

William Schmidt

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

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