R&D investment reduces current profits, so short-term pressure to hit profit targets may distort R&D. In the data, firms just meeting Wall Street forecasts have lower R&D growth and subsequent innovation, while managers just missing receive lower pay. But short-termist distortions might not quantitatively matter if aggregation or equilibrium dampen their impact. So I build
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R&D investment reduces current profits, so short-term pressure to hit profit targets may distort R&D. In the data, firms just meeting Wall Street forecasts have lower R&D growth and subsequent innovation, while managers just missing receive lower pay. But short-termist distortions might not quantitatively matter if aggregation or equilibrium dampen their impact. So I build and estimate a quantitative endogenous growth model in which short-termism arises naturally as discipline on conflicted managers and boosts firm value by about 1%. But short-termism reduces R&D, and the social return to R&D is higher than the private return due to standard channels including knowledge spillovers and imperfect competition. So at the macro level, short-termist distortions slow growth by 5 basis points yearly and lower social welfare by about 1%.
That is from Stephen J. Terry, recently published in Econometrica. Via the excellent Kevin Lewis.
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Economics, Uncategorized