The Cost of Being Short Term: How Engineered Share Buybacks Undermine Firm’s Long-Term Productivity
Research finds earnings-driven stock buybacks can undermine companies’ long-term productivity today. Ershain's work shows that cuts to technology, machines and skilled jobs can weaken efficiency for years.
Renowned leaders like Jamie Dimon and Warren Buffett have called out corporate short-termism that harms growth, strategy, and even firm sustainability. But evidence about the real impact is sparse. In a recently published study, associate professor of finance Nuri Ersahin and coauthors offer evidence that meeting short-term earnings targets with buybacks can sacrifice long-term productivity. Looking across an important 25-year period, Ersahin gets “under the hood of the U.S. economy.”
Short term impacts long term
Critics of short-termism argue that cutting investment, including employees, to hit quarterly targets can destroy value. “EPS-motivated stock buybacks occur when a firm is just about to miss the consensus analyst earnings forecast for the quarter,” Ersahin comments. “And to avoid missing that target, management authorizes share buybacks to reduce the share count, and nudge the earnings per share just over the line.” The aftermath has consequences however.
In plant-level data from the U.S. Census Bureau, Ersahin and coauthors analyzed data from 1988-2013. The study tracked firms over the three years following EPS-motivated buybacks. The results challenge the “trimming the fat” narrative. “If firms were only cutting their poorest performing projects, overall productivity should stay flat or even increase,” says Ersahin. “But instead, productivity declines, and so it actually harms the firm's longer term operational efficiency.”
Productivity takes a real hit, according to the research. Total factor productivity, a broad measure of how efficiently a firm converts inputs into outputs, fell by approximately 1.3% at studied firms. Ersahin notes, “This 1.3% drop might sound small, but in the context of manufacturing, it's a massive hit to efficiency and profit margins.” Importantly, the productivity decline itself tells the tale.
Remarkably inefficient
“We expected firms to protect their most productive plants—their crown jewels in a sense—and direct investment cuts towards their underperforming facilities,” Ersahin recalls. The authors find the opposite by firms engaged in short-term financial engineering practices. He adds: “Firms allocate the investment cuts indiscriminately across their plants, irrespective of whether the plant is highly productive or unproductive. The cuts are remarkably inefficient.”
The granularity of the data allowed the researchers to dig deeper into the nature of investment cuts that follow the buybacks. On the capital side, firms slashed spending on machinery and IT equipment. On the labor side, the pattern was more nuanced: cuts to blue-collar production workers were spread evenly across all plants. However, reductions in white-collar, non-production personnel, such as supervisors and technical staff, were actually concentrated in the most productive facilities. In essence, those employees focused on innovation and operations at a firm’s best plants were among the casualties of short-term earnings pressure.
Additionally, by splitting the sample into states with and without right-to-work laws, the team found that union strength plays a role in where and how cuts occur. Ersahin recounts, “Where unions are stronger, firms cannot easily execute surgical cuts or close underperforming plants. Managers then resort to more indiscriminate across-the-board cuts.” Alternatively, in right-to-work states, managers of firms resorted to more efficient cost cutting.
Owing to the time period, the study was able to capture a critical period of IT adoption in U.S. manufacturing. Firms under short-term pressure reduced “technology-embodied capital,” that is, spending on new machinery, computers, and software. Ersahin says, “[IT investments] are easy to pause or cancel when you need to subsequently cut investment to fund buybacks. The problem is your long-term efficiency can suffer.” Looking ahead, Ersahin notes that the implications for AI investment could be even more significant.
What leaders can do
Ersahin acknowledges the real pressures firms face to meet quarterly targets. Rather than using a short-term buybacks strategy to boost earnings, he believes better communication with investors is the answer. Rather than resorting to buybacks: “Firms don't want to miss their technological investments or long-term goals.” Ersahin advises that CEO contracts and compensation be tied to long-term strategic goals to solve this short-term versus long-term clash.
While the study focuses on U.S. manufacturing, the lessons are not unique to any sector or geography. “We focused on manufacturing firms here, but I think the results are generalizable to all industries,” he concludes. Firms in many sectors are wrestling with AI investment, automation, and workforce development. The study pinpoints the real costs of short-termism. Lower productivity, unoptimized workforces, and deferred capital and technology investments can then take years to reverse.
The paper “How Do Short-Term Incentives Affect Long-Term Productivity?” with Nuri Ersahin of Cox School of Business, Southern Methodist University; Heitor Almeida of University of Illinois at Urbana-Champaign; Vyacheslav Fos of Boston College; Rustom Irani of University of Illinois at Urbana-Champaign; and Mathias Kronlund of University of Illinois at Urbana-Champaign was published in the Financial Review journal.
Written by Jennifer Warren.
Video
Short-Term Incentives: A Conversation on Research
See the accompanying vlog on Associate Professor of Finance Nuri Ersahin's research on short-term incentives and long-term results.
