Private Firms Invest Longer-term Than Public
Robin Hanson notices some strong evidence that publicly traded companies under-invest:
The number of new businesses we get seems limited by the number of folks personally wealthy enough to start new businesses. So having more really rich folks benefits everyone via innovation.
Now I learn that very rich folks are crucial not only for business starts, but also for most investment that takes more than a year or so to payoff! Consider:
As is common in factories, [public firm] Standard [Motor Products] invests only in machinery that will earn back its cost within two years. (The Atlantic, Jan, p.66)
Why look at years-to-payback instead of return on investment? A new NBER paper on private vs. public firms makes the answer clear. Unless project gains can be very clearly proven to analysts, or perhaps so small and numerous to allow averaging over them, public firms are basically incapable of taking a loss on earnings this quarter in order to make gains several years later, no matter how big those gains. CEOs are strongly tempted to instead please analysts by grabbing higher short-term quarterly earnings. So we need the very rich to make long-term investments.
I buy that private firms aren’t so busy optimizing “profits” (may avoid them for tax reasons?), and that many public firms sacrifice long term health for the current quarter (e.g. Sears’ low investment in improving its stores). but you can’t make every investment that computes as NPV-positive or you’ll end up with a bunch of losers (as in multiple hypothesis testing, your threshold has to trade off false positives and negatives). Perhaps some private firms over-invest out of hubris.
We could ask: assuming a list of investments sorted by projected future returns, (thus NPV given a discount rate), what discount rates and thresholds (below which you reject the investment even if you can obtain the capital for it) do firms seem to be using? It’s quite plausible that public firms are both shorter-horizon and more conservative (bosses don’t want to get fired, or want to boost the value of their stock).