A New Study Analyzes the Language Used by Top Management Teams to Predict When They'll Prioritize Short-Term Gain over Long-Term Health

After Dell Inc. went private in 2013, its founder Michael Dell spoke about “an affliction of short-term thinking that drove a wedge between our customer and investor priorities” and how “shareholders increasingly demanded short-term results to drive returns…”

A 2021 survey of 500 global executives, jointly conducted by McKinsey and Focusing Capital on the Long Term, found that top managements continually feel pressured to meet near-term earnings targets at the expense of long-term strategies. In other words, they engage in myopic decision making such as cutting marketing and R&D expenses to boost short-term earnings, prioritizing sales over customer satisfaction, offloading inventory at fiscal closing, and withholding new product launches. These behaviors are commonly observed prior to seasoned equity offerings (SEOs), initial public offerings (IPOs), share repurchases, and C-suite retirements.

According to the survey, myopic decision making decreases “long-term growth investments by 17 percent, on average, when faced with a 15 percent decrease in revenue.” Myopic spending harms stakeholders, including investors, customers, and boards of directors. It is also associated with inferior stock market performance in the long run due to loss of market share and delayed innovation.

Predicting myopic marketing spending would help stakeholders prior to quarterly earnings calls. Investors, who are currently forced to wait until firms release quarterly financial statements to determine whether to buy, hold, or sell, could reallocate their investments and preserve more of their portfolio’s value. Additionally, the board of directors could react or intervene before the earnings call, not after.

In a new Journal of Marketing study, we propose a method for predicting myopic marketing behavior up to a year in advance. Our method involves analyzing the language that Top Management Teams, or TMTs, use in earnings calls. By parsing close to 11 million sentences extracted from nearly 25,000 quarterly earnings call transcripts between 2008 and 2019, we measure how TMTs discuss marketing and earnings and predict the likelihood of firms cutting their marketing and R&D spending.

Value for Investors

Our proposed approach offers actionable benefits.

Predicting myopic marketing spending a year in advance will give investors access to private information, which can be used to create an arbitrage opportunity. Investors can use our approach to divest from firms before they suffer the detrimental, long-term consequences of myopic spending.

Generating high-frequency forecasts (e.g., at the quarterly level) are more useful than existing approaches that use infrequent events such as SEOs, IPOs, and TMT retirements. Investors will have up to four opportunities a year to predict myopic marketing spending and thereby rebalance their investment portfolios.

Compared to current approaches used to predict myopic marketing spending, our proposed method provides superior forecasting accuracy.

Lessons for Investors and Other Stakeholders

Our study’s findings reveal that executives are more likely to engage in myopic marketing spending when they discuss increasing earnings during quarterly earnings calls. Conversely, conversations about increasing marketing or decreasing earnings reduce the likelihood of such behavior in the future.

Investors:

Additionally, we compare the financial returns of firms that engage in myopic marketing spending to those that do not. We show that avoiding investing in myopic firms yields an additional 6.44% in returns over four years, which translates to 1.61% annual abnormal returns over existing prediction methods.

Corporate governance:

Previous research has shown that internal governance implemented through incentivization and information provision to subordinates of C-suite executives can reduce C-suite earnings management. With our approach, subordinates of the C-suite and other boards of directors can monitor TMT behavior. We suggest that internal and external governance entities pay attention to what TMTs say during earnings calls to reduce the problem of information asymmetry.

Competitors:

The early prediction ability could also be leveraged by firms’ competition. Intentions to engage in myopic marketing spending could translate into significant advance notice for formulating competitive strategies that can result in superior performance (e.g., product-market entry, R&D commitments).

Marketing officers:

Marketing firms and advertising agencies could gain strategic foresight into potential contract cancellations due to the firm’s intentions to cut marketing spending and engage the firm or alter plans accordingly.

Top management teams:

We anticipate that the reduced cost of monitoring the TMT’s myopic marketing spending behavior can have two potential outcomes:

Reduced monitoring cost would lead to greater oversight over TMT actions, which can lead to a decrease in myopic marketing spending.
TMTs may adapt their language to prevent detection, but our approach can be refined to adapt to changing TMT language.

Future work could analyze audio and video components of earnings calls to assess nonverbal predictors. Scholars could also focus on creating a continuous measure of myopic marketing spending to capture more variation.