Executive Summary
Effective management requires a long-term focus and choosing strategic alternatives that yield an overall highest expected net present value (i.e., strategies that maximize the sum of the discounted future profits). Thus, the strategic alternatives that managers select depend both on the expected cash-flow stream and on the discount rate they use. The discount rate is what determines the balance between current and future-term focus. Increased managerial discount rates can lead to inefficient decision making and can adversely affect a firm’s future performance. Managers often face incentives and feel pressures that increase their effective discount rates and lead to an overemphasis on the short run. For example, managers feel pressure to meet earnings projections because the financial markets punish companies (e.g., driving down their stock price) that fail to meet analysts’ expectations. At times, managers’ personal motivation (e.g., career advancement considerations) and compensation structure might also increase the discount rates they use. For example, when managers approach retirement or the expiration of their stock option grants, they desire a higher stock price and might try to manipulate the signals they send to the stock market in an attempt to inflate the stock price and maximize their personal income from the options sale.
In practice, manipulation of performance signals can be undertaken through myopic management (manipulation of real activities) and through accounting-based earnings management (discretionary accruals manipulation). Because managers can use judgment in financial reporting (e.g., accelerating recognition of revenues, capitalizing rather than expensing some costs, delaying write-offs, understating bad debt) and in structuring transactions, they can manipulate discretionary accruals (i.e., components of earnings subject to accounting discretion) to alter earnings numbers in financial reports. Although such practices can have negative consequences for a firm when uncovered (lawsuits, increased auditors’ scrutiny), they do not affect the foundations of firm business performance and do not alter either the amount or the temporal flow of true economic profits.
Conversely, myopic management, such as underinvesting in research and development, advertising, and employee training for the purpose of meeting short-term goals, will affect economic profits. Myopic management involves altering operational practices and directly affects the business process. When initiated at the top organizational level, myopic management poses particular challenges to marketers. Both anecdotal and empirical evidence suggest that marketing is often treated as discretionary. For example, marketing spending is commonly the first line item cut in an economic downturn or when managers fear they might not be able to meet their earnings targets.
The author assesses the total financial consequences of myopic management (the practice of cutting marketing and research-and-development spending to inflate earnings) and finds that myopia has long-term net negative impact on firm value. Myopic management is contrasted with accounting accruals-based earnings inflation, and it is shown that myopic management has a greater negative impact on future financial performance than accounting numbers manipulation. The results are consistent across alternative abnormal return measures and alternative benchmarks. The author discusses the role of shareholders, managers, and marketing researchers in limiting myopic management practices.
Biography
Natalie Mizik is Visiting Associate Professor of Marketing, Sloan School of Management, Massachusetts Institute of Technology, and Gantcher Associate Professor of Business in the Columbia University Graduate School of Business at Columbia University, where she has been on the faculty since 2002. She holds a PhD in Business Administration from University of Washington and an MS in Economics from MGIMO University, Moscow, Russia. Her research focuses on financial implications of managerial decision making and on valuation of intangible assets. Her research has been recognized by the Marketing Science Institute (Young Scholar’s Program 2005, Grants 4-1316 and 4-1455) and Institute for the Study of Business Markets (2001 fellowship). Her work has appeared in Journal of Marketing, Journal of Marketing Research, Marketing Letters, Marketing Science, Management Science, and Harvard Business Review. Natalie teaches core and elective marketing courses to MBA and executive MBA students.
Journal of Marketing Research, Volume 47, Number 4, August 2010
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