Under Pressure: How Financial Analysts and Investors Contribute to Short-Termism

Abstract

Short-termism in organizations is argued to lead to suboptimal long-term outcomes. Financial markets are often seen as the source of organizational short-termism because of short-term profit expectations of investors. In this paper, we argue that financial markets contribute to organizational short-termism in other ways. We apply a temporal lens to prospect theory, arguing that time horizons shorten when firms fail to meet performance expectations. Specifically, when analysts downgrade their buy-sell recommendations or when firms do not meet analysts' consensus earnings forecasts, firms are likely to exhibit short-termism. We analyze 644 conference call transcripts of 23 firms in extractives industries over 7 years to measure the firms' time horizons. We find that analyst downgrades and reported earnings below the earnings consensus forecast result in the greater use of short-term language in the call transcripts. Both of these negative relationships are amplified when more investors with short time horizons hold company stock, while the latter is strengthened when more financial analysts cover a firm. Given that most firms will experience disappointing results at some point in their life cycle, our findings help to explain escalating short-termism among publicly held firms.