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Short-termist behaviour among investors appears to have rubbed-off on companies. Poterba and Summers (1995) surveyed Chief Executive Officers (CEOs) at Fortune-1000 firms. They found that the discount rates applied to future cash-flows were around 12%, much higher than either equity holders' average rate of return or the return on debt. This excessive discounting implied that some firms were rejecting positive net present value (NPV) projects. Echoes, here, of Pigou's defective telescope.


Most recently, in 2011 PriceWaterhouseCoopers conducted a survey of FTSE-100 and 250 executives, the majority of which chose a low return option sooner (£250,000 tomorrow) rather than a high return later (£450,000 in 3 years). This suggested annual discount rates of over 20%. Recently, Matthew Rose, CEO of Burlington Northern Santa Fe (America's second biggest rail company), expressed frustration at the focus on quarterly earnings when locomotives lasted for 20 years and tracks for 30 to 40 years. Echoes, here, of "quarterly capitalism".


So short-termism implies that projects with positive returns, or a relatively short payback, may be misperceived as being negative return or having a relatively lengthy payback. These projects would fail to receive financing. Investment and, ultimately, growth would be lower than optimal. In fact, the potential capital misallocation problem is greater still.

So we're back to discount rates- again.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Mon May 23rd, 2011 at 06:04:23 AM EST

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