Are markets short term?
There are many who believe that stock price maximization leads to a short term focus for manager - see for instance Michael Porter’s book on competitive strategy. The reasoning goes as follows: Stock prices are determined by traders, short term investors and analysts, all of whom hold the stock for short periods and spend their time trying to forecast next quarter's earnings. Managers who concentrate on creating long term value, rather than short term results, will be penalized by markets.
Most of the empirical evidence that exists suggests that markets are much more long term than they are given credit for:
1. There are hundreds of firms, especially small and start-up firms, which do not have any current earnings and cash flows, do not expect to have any in the near future, but which are still able to raise substantial amounts of money on the basis of expectations of success in the future. If markets were in fact as short term as the critics suggest, these firms should be unable to raise funds in the first place.
2. If the evidence suggests anything, it is that markets do not value current earnings and cash flows enough and value future earnings and cash flows too much. Studies indicate that stocks with low price-earnings ratios, i.e., high current earnings, have generally been underpriced relative to stocks with high price-earnings ratios.
3. The market response to research and development and investment expenditure is not uniformly negative, as the 'short term' critics would lead you to believe. Instead, the response is tempered, with stock prices, on average, rising on the announcement of R&D and capital expenditures.
